Definition
The cup-and-handle chart pattern is a bullish technical setup. While there is some interpretation involved, it's a nice pattern because of its simplicity, and its similarity to a straightforward breakout pattern. In the end, it relies on a break above a series of prior highs, which is a clear and simple chart price to discern.
The cup-and-handle is formed by an uptrend's high first being made. After that the stock price will decline (left side of the cup), generally in a more or less stable and controlled way. A rounded bottom will be made followed by an equally stable and controlled rally (right side of the cup) which ends at the same high that the left side of the cup began. This rally fails again at this high and now forms the handle of the cup by moving sideways and lower. This drop should be around 1/4 to 1/2 the height of the cup.
All of this is just the setup leading to the actual trade.
The trade occurs when the handle's decline ends, and it now rallies back to the highs. This will be the third time the high is tested, and the purchase of the stock will take place just above those highs, as the price breaks out.
The target price for the breakout is the height of the cup portion. If the cup went from $100 to $90, then the target is $110. Of course, the target is not a hard and fast number. Appropriate stops should be used as the trade progresses.
A cup should form over a number of months, and the handle over a few weeks. Occasionally very large multi-year formations will occur, and they can be considered as well, but generally this is not a pattern you should see develop completely over just a few days or weeks.
No chart pattern is perfect from start to finish, though, so let's go over a few examples below.
IDXX's cup forms over the course of just over two months. I wouldn't go a lot shorter than this. The drop of the handle takes almost three weeks. The handle rally fails briefly right at the top of the cup resistance, then pops through and runs almost in a straight line for two months.
The NFLX cup is formed over about seven months, covering three separate earnings seasons which cause some blips along the way, but overall it's a nice cup shape. The timeframe for the handle is good, but this one runs a little deeper than the 50% we'd like to see. The subsequent rally breakout is exactly what we like to see, though, with a clear break of the old highs and good follow through.
This JBHT cup-and-handle is an interesting one. The cup is formed nicely, followed by a handle that once again drops a bit deeper than we'd like. Then as the handle begins to rally off the bottom it gets a big gap higher jump on earnings that pops it through resistance and gives it a nice run higher.
SONO's cup-and-handle is a pretty good one. There are only a couple small glitches along the way. One is the blip at earnings right as the handle portion began to form. The other is how long it took the handle to complete before the big breakout and rally finally came along. Overall, though, this is a pretty solid example.
Summary
The cup-and-handle is essentially a breakout pattern, which we are big fans of at Wanderer. By testing a high three times the number of sellers is often exhausted, and the break to a new higher level will often flood the market with new buyers, creating a strong rally. This pattern is relatively easy to spot, and has good reward-to-risk if entered shortly after the breakout occurs. A common way to play these is to buy when the price goes 1% above the previous high (top of the cup), and use a stop of 1-2% back below that high in case the breakout fails.
Armed with this you should now be able to spot new setups as they are developing. Be sure to zoom in and out on your charts through different time frames as this can often make them easier to spot. Good luck!