You may know that a cup-with-handle base is one of the most successful chart patterns for growth stocks. Why are handles important and how do you spot a proper one? Let's delve into the characteristics.
A handle defines the proper entry. The highest price in the handle plus 10 cents creates a new buy point for investors. Handles can also appear in double bottoms.
Ideally, a handle should be at least one or two weeks in duration, emerging from a seven- to 65-week long cup base. It should form in the upper half of the cup when measured from the cup's peak to the bottom, and it should be above the 10-week moving average.
Handles should be no more than 12% deep from top to bottom in bull markets, otherwise it's considered too risky. They can go as deep as 20%-30% in bear markets and still work, if the general market starts a new major uptrend, IBD founder William O'Neil wrote in "How to Make Money in Stocks."
A proper handle should drift downward, creating a shakeout of weak holders. Volume should be drying up and fading into the end of the handle, indicating there are no more sellers to unload shares.
The stock will need a catalyst to spark interest and attract buyers once again.
How To Buy Stocks: Cirrus' Faulty Handle
Let's look at an example of a faulty handle that tricked investors.
Cirrus Logic was in a 51-week-long cup base with a handle that formed in December 2021.
The stock traded in volatile action as the handle formed, closing near weekly lows as volume increased. The handled also sloped upward (1). This was weak, uncertain action. At this point in the pattern, the stock should be easing in declining volume and drifting downward.
The stock attempted a breakout the week of Jan. 14, as it topped the 95 buy point (2). But the breakout failed. Shares traded sideways then started a choppy descent. Cirrus didn't hit 95 again until two years later, in February 2023.
How To Buy Stocks: Spot Handle Flaws
Handles that form in the lower half of the cup or below the 10-week line are considered weak and failure-prone. It shows demand has been too weak to push share price from lows to the upper half of the base.
Handles that drift upward along their price lows or sideways on lows, an action called wedging, have a higher failure rate. This happens because the stock didn't get a chance for the necessary shakeout. This often occurs in late-stage bases and laggard stocks.
You can see how following a few handle rules can help you avoid getting conned by an impostor.
Follow Kimberley Koenig for more stock news on Twitter @IBD_KKoenig.
