HOW TO TRADE INVERTED CUP AND HANDLE CHART PATTERN

How to trade inverted cup and handle chart pattern
Infographic - How to trade inverted cup and handle chart pattern

Entry: after breaking the surface at point (5), either with an entry after the breakout, or after a possible retest of the surface.

Take profit: identified by measuring the vertical distance from the the cup's high (2) to the cup's second resistance (3), that measurement is then applied from the breakout rate (5)

Stop loss: can either be the surface breakout rate (5), or the handle's high (4)

INVERTED CUP AND HANDLE PRICE ACTION

This chart pattern starts forming with bears already in control of the exchange rate's downtrend. As bulls enter the market, they slowly and steadily squeeze on bears, till the bears reverse direction and push the rate downwards in the same slow and steady manner. The same squeeze and reversal is then repeated in a narrower range and shorter time period, till the bears finally break the cup and handle's surface created by the bulls, and the exchange rate continues its downtrend.

Let's break down the pattern formation!

In a downtrend, price action finds the first resistance (1)

Price action reverses direction and goes upwards slowly and steadily till it finds the first support (2), which will be the highest high in the pattern.

Price action reverses direction from the first support (2) and goes downwards slowly and steadily, till it finds the second resistance (3), completing the cup formation.

Price action reverses direction from the second resistance (3) and goes upwards, till it finds the second support (4), which must be lower than the first support (2)

The pattern is completed when price action reverses direction from the second support (4) and goes downwards till it breaks the cup and handle's surface at point (5)

NOTES ON INVERTED CUP AND HANDLE

Direction

Continuation

Type

Bearish

Occurrence

Low

Common term

Medium-Long

The cup and handle surface is identified by drawing a trend line connecting both resistances of the cup formation (1-3)

Handle formation might be shaped as an up-sloped flag facing away from the surface.

Cup and handle's surface can be skewed.

Volume usually decreases as the pattern is being formed, and increases when breaking the surface or retesting the breakout rate.

This pattern is commonly found on medium-term and long-term time frames.

INVERTED CUP AND HANDLE REWARD:RISK

When using the surface's breakout rate as stop loss, R:R will depend on the (breakout rate-entry rate) distance, compared to the cup's height (2-3)

When using the handle's high (4) as stop loss, the pattern's R:R improves when the handle's height (4-5) is relatively short compared to the cup's height (2-3)

Always remember that both stop loss levels explained above are absolute, the actual stop loss rate for your trade setup should be a bit beyond those levels to give the trade setup some room to breathe, and of course, calculations for position size and R:R should be done with respect to those rates.

INVERTED CUP AND HANDLE REAL TRADE

Inverted cup and handle real trading example
Forex chart - Inverted cup and handle real trading example, as found on the H4 chart of GBP/JPY using FXCM's MT4 platform

PRE-BREAKOUT CALCULATIONS

Since an inverted cup and handle chart pattern can be spotted after the reversal from point (4), you can save yourself precious time by doing the following set of calculations before the breakout, since they don't rely on the trade's entry rate.

However, unlike other patterns where the breakout rate is fixed, an inverted cup and handle breakout rate is variable, depending on the time of the breakout. As a result, pre-breakout calculations are limited to pattern length and second stop loss.

  • Pattern length (point (2) rate - point (3) rate)
    • (149.298 - 145.242) * 100 = 405.6 pips
  • Stop loss #2 rate (point 4 rate + 10% of pattern length)
    • 147.133 + ((10 * 405.6 / 100) / 100) = 147.539

POST-BREAKOUT CALCULATIONS

The following set of calculations depends on the surface's breakout rate, which is the variable point (5). It is highly recommended to complete them as soon as a breakout occurs, so you can focus more on the calculations needed for the actual trade.

  • Take profit rate (breakout rate - pattern length)
    • 145.483 - (405.6 / 100) = 141.427
  • Stop loss #1 rate (breakout rate + 20% of pattern length)
    • 145.483 + ((20 * 405.6 / 100) / 100) = 146.294

TRADE SETUP

Choosing when to enter the trade after the surface breakout is always left to your best judgement. In this trade, we waited a bit after the surface breakout, and chose to enter the market at the closing rate of the first bearish candle that closed at a rate lower than that of point (3), since the pattern's surface was skewed and the breakout candle itself didn't break the previous resistance created at point (3)

  • Trade entry rate
    • At the closing rate of the first bearish candle that closed on a rate lower than that of point (3): 145.294
  • Take profit in pips (entry rate - take profit rate)
    • (145.141 - 141.427) * 100 = 371.4 pips
  • Stop loss #1 in pips (stop loss #1 rate - entry rate)
    • (146.294 - 145.141) * 100 = 115.3 pips
  • Stop loss #1 R:R (take profit in pips / stop loss #1 in pips)
    • 371.4 / 115.3 = 3.221
  • Stop loss #2 in pips (stop loss #2 rate - entry rate)
    • (147.539 - 145.141) * 100 = 239.8 pips
  • Stop loss #2 R:R (take profit in pips / stop loss #2 in pips)
    • 371.4 / 239.8 = 1.549

Currency pair

GBP/JPY

Timeframe

H4

Breakout

02-Aug-2018

Platform

MT4

Broker

FXCM