Today’s Trading Lesson From TradingMarkets

Editor’s Note:

Brice

Subtle But
Important Characteristics I Look For In Handles

By Greg Kuhn

When it comes
to identifying a proper cup-with-handle basing pattern, getting a
handle on the “handle” can be the trickiest part. A perfectly developed cup
formed over many weeks, with all of the right volume clues (see my

Trading Lesson on Volume Clues for an explanation), can turn into a bad
pattern in a matter of days, if the handle is formed improperly.

Nonetheless, upon recognizing a solid
cup formation, some traders will grow so anxious — especially if the stock has
all of the right fundamental and relative-strength characteristics — that they
lose sight of proper mechanics in a handle, and buy the stock breaking out
anyway.

Impatience leads to disappointment.

William J. O’Neil, founder and
chairman of Investor’s Business Daily, popularized the cup-with-handle
chart formation. His studies of the market’s biggest winning stocks revealed
that many of them broke out from this technical pattern en route to achieving
their large gains. In order to catch a stock breaking out from a sound basing
pattern for immediate gain, it’s important to wait for it to clear a chunk of
its overhead resistance first. This build-up of disappointed buyers during the
corrective phases of the cup, and now would-be sellers, typically keeps a lid on
the stock’s advance up the right side of the cup. Therefore, the search for a
handle should only begin once the stock is at least in the upper half of its
cup, preferably the upper third. Another way to characterize this is to look for
a handle when the stock’s price is within 5%-15% of the old high, on the right
side of the cup.

This is your initial guideline.

Handles can be as short as five
trading sessions, (in some rare cases, as short as three days — this was seen
with many, highly volatile Internet stocks in recent years), but are, typically,
longer. The main characteristic to look for is downward “wedging” action in
price during the formation of the handle. A one- or two-day shakeout move below
a prior low in the handle is also a common characteristic in a properly set
handle. Equally important, volume should dry up along the price lows in the
handle, and on the handle’s down days. This indicates light profit-taking from
the move up the right side of the cup.

Handles that consistently drift higher
along their price lows over several days have a very high failure-rate,
following a breakout. This is improper characteristic is normally seen in stocks
breaking out of latter-stage basing patterns of a longer-term advance, or in
very active leading stocks that have become too widely followed.

With the above notions in mind, the
best way to exemplify what a proper handle should look like is by sharing a
number of chart samples. The following samples should serve as your template for
what proper and improper handles look like.

In the case of the handle, a picture
is certainly worth a thousand words.

Improper
Handles 

Sometimes, stocks without handles can
break out and succeed. However, an examination of the setup just prior to the
breakout is still key. Did the stock just run straight up from its lows into new
high ground, or did it at least consolidate for a spell in the middle of the
right side of the cup?

Two classic examples of a
cup-without-a-handle. One succeeded, one didn’t. Here’s why:

Can you see the difference between
these two cup-without-handle patterns? Newport Corp. broke out of consolidation
within 15% of its old high, while the only real pivot point for California
Amplifier was at $32 – 35% off the old high. Again, as a good guideline, the
best pivot points will setup within 5-15% of the stock’s old high.

Proper Handles

In the above example, the handle
formed what’s referred to in technical parlance as a bullish ascending triangle
— ascending in price underneath, but flat along the top. This should not be
confused with an improperly “wedging” handle, which will not be flat
along its price highs.

Notice how, like Newport Corp’s
cup-with-handle-looking consolidation within its overall base, the handle in
Knight Trimark’s 10-week cup-with-handle formation forms into a small
double-bottom pattern. It has two distinctive sections, separated by a midpoint,
with the second low in the “W” undercutting the first one. A trader recognizing
this nuance in a handle could begin buying as soon the price passes 1/8 point
above the midpoint in the handle’s “W”.