Subtle But Important Characteristics I Look For In Handles

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".

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