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The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

13 March 2005

The Cup & Handle

The cup & handle pattern is often seen but rarely confirmed -- just like Nellie in Loch Ness. The high incidence of sightings is due mostly to observers not knowing the rules of the pattern. So a primer, of sorts...

The Cup & Handle pattern is eponymously descriptive: after a strong upward move, the stock will pull back, and then return to the area of the recent high forming the distinctive shape of a cup. On the right side of the cup a handle forms as the stock trades within a well defined range for 1-3 weeks. The handle may show movement horizontally or with a downward slope. This pattern, then, seems sufficiently straight-forward, so how and where do the problems of interpretation occur? By the perceiver not applying the rules:

1) The Cup typically retraces about 15 to 35% of the recent price high. It must be shaped in the form of a "U" (or saucer-like), not a "V". It must not retrace more than 50% from the high. (This rule excludes all those stocks that have declined from $100 to $1/share, and then build the appearance of the pattern without abiding by its rules.) In addition, the cup should be several weeks to six months in duration.
2) The Handle must form in the upper half of the Cup and show generally decreasing volume. The high of the handle should be within about 5% of the high on the left side of the Cup. The low of the Handle should not be more than about 15% off the high of the handle.
3) Entry Point: when the price rises above the declining trend line formed over the highs of the Handle, or when the price rises above the high of the handle. The volume should be above average daily volume -- preferably explosively more -- on the day of the breakout.
4) Stop losses may be placed below the low of the handle, or ~$1 below the trend line formed across the highs of the handle.

The chart below shows a current example... (Yes, it is once again Flir Systems/FLIR.)


1) After a powerful advance (~$13 to ~$33), FLIR declined from that high trade of $33.34 (on 8.23.04) to a low of $24.59, a 26% decline. Confirmed. (Decline of <50%)
2) The cup (or base) endures for ~6 months until it breakouts with volume to new highs. Confirmed.
3) The high of the handle is within 5% of the erstwhile high, $34.95 new high vs the former high of $33.34. Confirmed.
4) The handle has so far consumed one week of an allowable three weeks. Confirmed.
5) Volume (in the handle) has diminished -- albeit with the notable exception of two large blocks that crossed in the closing 10 minutes of Friday's activity. Confirmed.

How does a setup and pattern become despoiled? Typically, via weakness in the markets at large. So maintain diligence, discipline, and patience, and recall always that stocks oscillate. Your objective, however, is to profit from those oscillations. And your task is two-fold:
1) To obey the entry and stop loss mandates as elucidated above, and
2) To share here (via the Comments link) the names of other stocks whose chart patterns display this cup & handle pattern. Heck, I have not somehow cornered the market in good (trading) ideas! (But do not neglect the rules for this particular pattern!)

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