Why are handles an important part of two key chart patterns, the cup with handle and the double bottom?
In a nutshell, these visual patterns represent a final significant decline in a stock, setting the stage for a possible surge to new highs. This final shakeout of weak shareholders acts as a verification that selling is done and the stock is ready to advance.
The breakout comes when institutional investors start buying like there is no tomorrow. That surge of volume powers the stock to its breakout and larger gains.
Here are some basic characteristics of the handle-related chart action to help you know if they are proper or not.
At Least Five Days
First, a handle is a moderate decline lasting at least five days. Most handles require at least a couple of weeks to form. The handle length is generally proportionate to the base. That means the longer the cup, the longer you can expect the handle to be.
Effective handles drift downward in price in declining trade. The light volume in the handle shows that the final shakeout of weak shareholders is different from intense institutional selling.
Moderate Decline
The handle’s decline must be contained. During normal market conditions, handle areas should not drop more than about 8–12%.
A midpoint of a handle should also form above the midpoint of the highest and lowest prices of the preceding base. To figure the midpoint, add the high and low points for the entire base, then divide by 2. Perform the same calculation for the handle.
If the result for the handle’s midpoint falls below that of the base, the handle is too low. Maybe that’s not a deal killer, but it adds risk.
A handle should also form above the stock’s 10-WMA. Research shows that — like handles that form below the base’s midpoint — breakouts from handles formed below the 10-week line are failure-prone.
Lows Shouldn’t Drift Upward
The lows in the handle should not drift upward. Such action is called wedging, and it usually leads to failed breakouts.
VIP Industries, India’s leading luggage manufacturer, built a first-stage cup-with-handle base pattern about two years ago.
Its stock corrected 29% in a 17-week-long consolidation that began in November 2016 (1).
As it approached the previous high of Rs 157, shares witnessed a final shakeout beginning with the action on February 17, 2017. That was Day No. 1 of what would become a two-week handle (2).
It remained sideways with volumes drying up in the counter, indicating a final shakeout of weak investors (3).
On March 2, Vip Industries broke out above the handle’s high of Rs 155, but reversed lower and closed 4.1% below the pivot. It maintained its sideways trend until a strong buying session on March 10 brought it back in its ideal buying range (4).
In the next 17 months, massive acceleration in sales and earnings growth saw institutions lining up to buy the stock, resulting in a whopping 316% gain (5). It managed to trade above its long-term 40-WMA throughout the period, giving patient investors no reason to sell it.
This actually answered my drawback, thank you!