Cup with handle, the classic bullish chart pattern

Interesting stuff..

On Friday February 12, 2010, 5:12 pm EST

Of all the bullish chart patterns � bases and add-on points alike � the classic seems to be the cup with handle. It’s the most successful pattern, likely because it represents some elements of human nature.

So what is a proper cup with handle?

The pattern must run at least seven weeks from the stock’s prior high. Sometimes the pattern can take months or more than a year to take shape.

The base’s buy point should be no further than 15% or so from the stock’s 52-week high.

The cup should be no deeper than 35%, though that limit can be stretched in a bear market. The market crash of 2008 made for some deep yet adequate bases in the context of that severe decline.

Like any base, the stock must show a prior uptrend of no less than 30%, or 20% from a previous breakout. Ideally, the left side is constructed in a not-too-sharp manner. A sudden plunge makes for a somewhat flawed left side.

In the same way, a sudden surge to create a right side is also a flaw. If the stock has both, it is said to be a V-shaped base, prone to failure.

Volume will probably spike some as the stock falls, and hopefully pick up as it climbs the right side. Ideally, you’d like to see calm, smooth left and right sides. Now, what about that space in between the left and right sides? That’s the base’s bottom. Don’t fret if the bottom lies below the 10-week moving average, as long as the breakout is placed above that crucial line.

Along the lows, volume should calm down. Unlike the impatience shown when the stock is falling, most of the players have turned their attention elsewhere.

So who’s buying it down there? Often, smart fund managers and others who have pegged this as a bargain. They’re not chasing the stock, they’re just setting an invisible net under the stock to catch whatever someone wants to throw away.

Why shouldn’t you buy the stock at the base’s bottom?

Simple � you don’t know it’s the bottom until after the base is completed. Nor do you know that the left side is a left side, or that the right side is a right side.

Many times has a stock plunged from what had looked like a cup’s bottom. It had just been a pause within a larger decline.

At some point, the weak hands and impatient sellers will be washed out. Now, if the bulls want any more shares, they have to pay up a bit. They have to raise that invisible net.

This shouldn’t be a sudden rush to buy the stock. That would make for that imperfect, sharp right-side incline. No, you’d rather see a smoother, somewhat gradual rise. Volume should pick up as big investors start to accumulate shares.

As the stock nears the left-side peak, those sellers will likely stall the rally. The stock declines.

But it shouldn’t dive. The stock should decline in an orderly fashion. This is how the handle forms.

Handle Characteristics

The handle must take at least five days to form and should be visible on the weekly chart. It should not sag more than 12% to 15%. Volume should be calm in this area of the base, and the price action should be fairly calm too.

The handle should form in the upper half of the base. Low handles are prone to failure.

The handle’s highest point, plus a dime, gives you the stock’s buy point. Voila.