How to Recognize Cup and Handle Formation when Day Trading
Stock markets tend to move in cycles. So, day traders and technical analysts tend to look for patterns in the price charts that give them an indication of how long any particular trend may last. The cup and handle formation is one such pattern.
When a security hits a peak in price and falls, sometimes because of bad news, it can stay low for a while. But eventually, the bad news works itself out, the underlying fundamentals improve, and the time comes to buy again. The technical analyst sees this scenario play out in a cup and handle formation.
The handle forms as those who bought at the old high and who felt burned by the decline take their money and get out. But other traders, those who haven’t the same history with the security, recognize that the price will probably resume going up now that those old sellers are out of the market.
A cup and handle formation generally shows up over a long period of trading — sometimes as long as a year — and many subtrends occur during that time. As a day trader, you’ll probably care more about those day-to-day changes than the underlying trend taking place.
Still, if you see that cup formation and the hint of a handle, you can interpret that as a sign that the security will probably start to rise in price.