Profit Today from Bullish Cup and Handle Pattern

The Cup with Handle is a relatively new technical pattern, the innovation of IBD founder, William O’Neil.  There are many who claim for and against the pattern, but we like it for the potential it offers when grouped with other techniques as part of a more comprehensive analysis.  The Cup and Handle is a consolidation pattern that indicates a breakout is imminent.

Let’s walk through the details of the Cup with Handle using a number of charts that currently exhibit the pattern.

To start, take a look at PepsiCo’s (NYSE:PEP) last six months trading.  Here we see the first of many conditions met: that the pattern unfold over a period of between seven weeks and a year.  In Pepsi’s case roughly six months was required.

From a technical standpoint, there are a number of other reasons why we like PepsiCo here.

1. It bottomed on July 1st, a full two weeks before the rest of the market, and has been rising ever since.

2. On that same day it evinced a bullish, candlestick engulfing pattern – followed by a more convincing “Three Outside Up” pattern, from which it has never looked back (circled on chart).

3. The break above the handle’s high point was made on convincing volume – at least 50% greater than the average daily trade.

4. The move above the handle also coincided with a break above the 200 DMA (day moving average), and all the trade since has been above that former line of resistance.  Even the Lehman induced 500 point Dow sell off couldn’t disturb PepsiCo’s equilibrium.

5. RSI shows healthy strength for the move already from May of this year.  At that time this represented a positive divergence for the stock – an equally healthy sign.

PepsiCo looks dandy enough.  But let’s push on.

Here’s a look at the last six months of Old National Bancorp (NYSE:ONB).  Be warned: this is a traditional full-service bank, offering everything from basic deposits to commercial and consumer loans, brokerage services, lease financing and insurance.  Not a whole lot scarier than that in today’s market.  Now take a look:

The next set of conditions that should be met for a proper Cup and Handle require the cup to trace out a loss of between 15% and 30% to the bottom of the cup – though in bear markets stocks may lose as much as 50% in the cup phase.  Next, the handle area should slant lower as the last sellers capitulate.  At that point the stock reverses and overcomes the high point of the handle on a pickup in volume.  Fifty percent greater than average volume suffices as a legitimate buy signal.

Old National Bancorp fits the bill to a tee. 

1. A huge surge in volume (roughly 2x the average daily trade) marks the break above the handle.  And, as you can see, since the beginning of August all the trade has taken place above the 200 DMA. 

2. And what’s this?  A bank trading higher for four of the last five sessions?  When AIG and Lehman have brought disaster to the markets!  How could it be?

3. RSI is positive and rising since the mid-July bottom.

There are dozens of stocks in similar uptrends from every market sector.

Here we are, smack in the middle of a “financial crisis” whose responsibility could reasonably be pinned on the housing sector – and what’s this?  Another shocker!  A homebuilder (just one among many, I might add) whose chart bespeaks a bullish turnaround.

The name of the company is Beazer Homes (NYSE:BZH), and they (gasp!) do what homebuilders do: they design, sell and build single-family dwellings across the U.S.  Until February of this year they also offered mortgage services.  The company is active in 21 states.  Here’s the chart:

The Beazer chart demonstrates the final two items regarding the Cup and Handle pattern: volume and price target.

• The decline into the cup should be accompanied by a reduction in share volume (as shown in the red rectangle).
• Price targets are calculated by measuring the distance from the bottom of the cup to the right peak of the cup (shown in blue, on right), and doubling.

Beazer’s target price after bettering its handle is roughly $12.50.  A solid gain for an $8.00 purchase today.

Beazer also shows

1. A positive divergence in RSI, and

2. A doubling in daily volume as it catapulted above its handle and its 200 DMA.  The resultant gap was covered the following day and the stock now appears ready to move higher.

Note that here, too, the “Wall Street Meltdown” caused no technical damage to the stock of a homebuilder who is supposed to be feeling the shock of the greatest credit crunch of the last half century.

For more examples of Cup and Handle formations on great companies in some not so great sectors, check out Wells Fargo (NYSE:WFC), First Merit Corp (NASDAQ:FMER) and Allergan (NYSE:AGN).

Make money.

Cheers,

Matt McAbby
Analyst, Charts of the Week