Complete Guide to Trading the Inverted Cup and Handle Pattern
The Complete Guide to Trading the Inverted Cup and Handle Pattern in 2024
The inverted cup and handle is an important bearish reversal chart pattern that every trader should know. This pattern can signal potential short opportunities at market tops.
In this complete guide, you’ll learn:
- What the inverted cup and handle is
- How to identify the pattern
- How to confirm the pattern
- How to set up trades
- Tips for effective trading
- Common mistakes to avoid
Plus we’ll look at real chart examples so you can see exactly how it works.
By the end, you’ll have all the knowledge needed to start trading inverted cup and handle patterns effectively.
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What is the Inverted Cup and Handle Pattern?
The inverted cup and handle pattern forms during an uptrend. It signals the uptrend is losing momentum and is likely to reverse into a downtrend.
It gets its name from the distinct shape — an upside down “cup” followed by a “handle”.
Here are the key features:
- Cup — The cup is a rounded top formation, like an inverted “U”. This forms as the uptrend peaks and prices start declining.
- Handle — After the initial decline, prices consolidate sideways or drift slightly upwards to form the handle.
- Breakout — The breakout triggers when prices close below the lower support level of the handle. This signals the start of the new downtrend.
Inverted cup and handle pattern
In a nutshell, the inverted cup and handle flips the traditional cup and handle formation upside down.
So instead of signaling upside breakouts in uptrends, it signals downside breakouts in uptrends — marking trend reversals.
Next let’s look at how to spot this pattern on the charts…
How to Identify the Inverted Cup and Handle
There are 4 key steps to identify inverted cup and handle patterns:
1. Find Existing Uptrends
Since this pattern signals reversals of uptrends into downtrends, you need to start by identifying existing uptrends.
Ideally the uptrend should have been underway for several months to have enough data to form the pattern. Monitor stocks trending nicely upwards for potential formations.
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2. Look for Rounded Peaks
Scan your list of uptrending stocks for ones showing rounded tops or peaks. This could take on an inverted “U” shape or a more angular “V” shape.
The previous uptrend should peak and start to decline when forming this top.
3. Watch for Sideways Handle Formation
After the initial decline off the peak, the price will typically consolidate sideways or drift slightly upwards. This forms the “handle” portion of the pattern.
Look for handles that drift no more than halfway back up the cup formation. Longer handles may invalidate the pattern.
4. Draw Key Support Levels
Draw a support line connecting the lowest points of the cup, and a support line across the bottom of the handle.
A break and daily close below the handle support signals the downtrend breakout.
Here is an example of an inverted cup and handle pattern forming on the stock chart:
Example inverted cup and handle
In this case, we can see the uptrend peak and form the rounded cup top. Prices decline to start forming the handle, which we mark with a support line.
A break and close below this level signals a short trade trigger.
Now that you know how to spot the inverted cup and handle, next we’ll look at how to confirm pattern validity…
Confirming Valid Inverted Cup and Handle Patterns
No chart pattern works perfectly all the time. There will be both winning and losing trades.
But there are two keys things you can check to improve pattern validity:
1. Check the Preceding Uptrend
Ideally you want to see a long and sustained uptrend preceding the pattern formation. This indicates strong bullish momentum is likely tiring.
Check for healthy uptrends lasting at least a few months and gaining 30% or more. Strong, mature uptrends make better reversal signals.
2. Watch for Increasing Volume on Breakouts
Volume can act as a useful confirmation tool. Look for an increase in volume on the downside breakout below the handle support.
Rising volume indicates increased bearish momentum and adds validity to the pattern signal.
Here is an example of rising volume confirming an inverted cup and handle breakout:
Inverted cup and handle breakout
Checking these two things — the preceding trend and breakout volume — can greatly improve your pattern confirmation.
Next we’ll look at a complete trade setup including entry, stop loss and take profit…
How to Trade the Inverted Cup and Handle
Trading the inverted cup and handle pattern involves three key steps:
1. Entry Order Below Handle Support
Place a short sell stop order slightly below the handle support level. This will trigger your entry as prices break support.
Use a stop limit order for optimal entry price control. I suggest placing stops 2–3% below support.
2. Initial Stop Above Handle / Cup High
Place an initial stop loss 5–8% above the high of the handle or peak of the cup formation. This allows some room for volatility while limiting risk.
3. Take Profit Targets at Key Levels
Set initial profit targets at previous support levels in the preceding uptrend. These act as likely areas of buying support on the way down.
You can also target a 100% measured move, which projects the depth of the cup downwards from the breakout.
Here is an example inverted cup and handle trade setup:
Inverted cup and handle trade
Let’s walk through this example…
We enter a short sell stop order at $42, which is triggered on the support break. Our initial stop loss goes at $46, while take profit targets sit at $37 and $34.
We close out partial profits at each target level as the downtrend unfolds.
There are also some common mistakes to avoid when trading this pattern…
4 Biggest Mistakes to Avoid
While powerful when traded correctly, the inverted cup and handle pattern does take some practice to apply effectively.
Here are 4 big mistakes to avoid:
1. Trading Poor Quality Patterns
Not confirming pattern validity or trading low quality patterns with no preceding uptrend. Take time qualifying each pattern before trading.
2. Entering Orders Prematurely
Entering orders before the actual support breakout. This results in failed trades stopped out for a loss. Wait for confirmation.
3. Placing Stops Too Close
Putting stops within the pattern or too close to the entry price. This will frequently stop you out on market noise. Give trades room to work.
4. Lack of Risk/Reward Planning
Not planning profit targets and appropriate stop losses in advance. Risk management is crucial for long-term success.
Being aware of these pitfalls will help you avoid making costly errors when starting out.
Finally, let’s look at some real chart examples…
Real Chart Examples
Studying real inverted cup and handle chart examples is hugely beneficial for learning how to trade patterns successfully.
Below are two charts highlighting inverted cup and handles in action:
Example 1
This daily chart shows software stock ADBE forming an ideal inverted cup and handle pattern during a steep uptrend.
We can clearly see the rounded peak and handle formation develop before a sharp decline. This collapse after the handle break resulted in a -35% fall.
ADBE inverted cup and handle example
Example 2
On this weekly chart example, we can see airline stock UAL form an inverted cup and handle lasting almost a year.
Despite the long timeframe, we still see a valid pattern with clear stages and a sharp decline after support gives way.
UAL inverted cup and handle example
These real examples demonstrate how the inverted cup and handle can form reliable reversal signals during sustained uptrends across various timeframes and instruments.
Now you know what to look for when analyzing charts!
Conclusion
As you have learned, the inverted cup and handle pattern is an extremely useful tool for traders.
It signals upcoming trend reversals — providing the perfect context for short selling opportunities.
By mastering this strategy, you’ll be able to effectively trade market tops and profit from declining prices.
The key now is to start spotting potential patterns forming on your own charts. It takes time and practice to apply these concepts successfully.
But with the complete knowledge you now have, you can take your chart reading skills to the next level.
So start scanning those charts today, and good luck trading the inverted cup and handle pattern!
