Base Series: Cup with Handle
The cup with handle is one of the most common and successful base patterns found in stocks. Its shape comes from a mild correction as the market corrects. Think of it as a basketball underwater. You can push it down, but there is a force that eventually wins pushing it back to the surface. Strong stocks are like this during a correction. The market may pull it down for a time, but strong fundamentals, institutions, and accumulation bring it back to near highs, often before the market turns around. These types of stocks create a type of cup pattern with a correction that is milder than the markets correction. A really good indication of this is a rising RS line during the correction, showing strength in the markets weakness. These stocks are usually the leaders when the market returns to an uptrend.
A solid cup with handle will usually be from seven weeks to six months long. They occur after a run up in price greater than 20% or so from a breakout. The correction from the top (forming the left side of the base) should be approximately 12% to 33%. Any more shows too deep of a correction. However, this must be analyzed from a realistic point of view. If the market has corrected 50%, then there might be good bases with much more of a correction (most good growth stocks correct 1.5 to 2.5 times the general market). As the base is built, the RS line must be improving, showing increased strength. As the right side of the cup is formed, volume should increase and show spikes on accumulation days.When analyzing the price action of the base, there should be areas of tight price action. Wide, loose bases are often faulty and fall apart. Volume should dry up at the bottom of the base (showing a switch from selling to buying) and in the handle (showing a lack of selling). Another way to analyze the base is to look at how many closes were up on higher volume compared to down. This will show whether the stock is under accumulation or distribution. Also, look at where the closes for the weeks were. If they were all in the upper half, it shows an inability for the bears to maintain much downward force.
This pattern (along with a few other bases) often has what is called a handle. The handle is one last correction that shakes out the last of the weak hands. The handle should last at least 5 days but could go for weeks. It is a breakout from this handle that initiates a buy signal when it appears on the chart. The handle (a price correction before the breakout but after the right side of the cup is formed) usually forms over 1 to 2 weeks. This downward drift in price should occur on lower volume and not correct more than 12%. Handles that drift upwards have a high failure rate and should be avoided. Also, the handle must be in the upper half of the cup pattern (measured from the old high to the corrective bottom). To prove the strength of the stock, the handle must be above the 10 week moving average.
The buy point for this base is a breakout above the handle high, with volume being 40% or more above the 50 day SMA of volume.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.