Anatomy of a Failure: How to Identify and Profit from Failed Cup and Handle Patterns

Not all Cup and Handle patterns lead to a breakout. In fact, many of them fail. Understanding why they fail and how to identify a failing pattern can be just as profitable as trading a successful breakout.

Entry Rules

A failed Cup and Handle pattern provides an opportunity to go short. The entry for a short trade is when the price breaks below the low of the handle. A sell-stop order can be placed $0.10 below the low of the handle. Confirmation of the breakdown is a daily close below the handle's low on high volume.

Exit Rules

Exit rules for a short trade on a failed Cup and Handle are the reverse of a long trade. A trailing stop-loss can be used to lock in profits as the price declines. A 2x ATR trailing stop from the entry price is a good starting point.

Profit Targets

The profit target for a failed Cup and Handle is the depth of the cup subtracted from the breakdown point. For example, if the cup depth is $10 and the breakdown is at $40, the target is $30.

Stop Loss Placement

The stop loss for a short trade should be placed above the high of the handle. This limits the risk if the breakdown turns out to be a false signal.

Position Sizing

Position sizing for a short trade is the same as for a long trade. The 2% rule should be applied to limit the risk per trade.

Risk Management

Risk management for a failed Cup and Handle involves understanding the context. Is the broader market in a downtrend? Is the stock in a weak sector? These are factors that can increase the probability of a failed pattern.

Trade Management

Trade management for a short trade requires discipline. It is important to stick to the plan and not let emotions interfere with your trading decisions.

Psychology

The psychology of a failed Cup and Handle is one of disappointment and fear. The bulls who were expecting a breakout are now trapped and are forced to sell, adding to the selling pressure.