Buying Earnings Winners in Structural Bases: The Cup-with-Handle Approach

Successful stock trading often involves identifying patterns that signal potential gains. One such pattern is the cup-with-handle base, which can be an effective way to buy earnings winners. In this blog post, we will discuss how to spot stocks building the right side of their bases after a strong earnings reaction and use pivot points as entry levels. By understanding these concepts, you can leverage your stock trading skills and capitalize on momentum plays.

The cup-with-handle pattern consists of two main components: the cup and the handle. The cup resembles a “U” shape and represents a period of consolidation after a stock has experienced a prior uptrend. The handle, a smaller consolidation, forms on the right side of the cup and serves as the final pause before the stock resumes its uptrend. Here are a few characteristics to look for when identifying a cup-with-handle pattern:

Prior Uptrend: The stock should have experienced a significant uptrend, usually at least 30%, before the cup formation begins.

Cup Depth: The depth of the cup should not exceed 50% of the prior uptrend. Deeper cups may indicate underlying weakness.

Cup Duration: The cup should be at least 6-8 weeks in length, with longer cups being more reliable.

Handle Duration: The handle should last at least one week but not more than a few weeks. It should also form in the upper half of the cup.

Volume: The volume should generally decrease as the cup forms and increase as the handle forms, with a further increase during the breakout.

To find stocks that are building the right side of their bases after a strong earnings reaction, focus on the following:

Earnings Growth: Look for companies that have recently reported strong earnings growth, as this can serve as a catalyst for a cup-with-handle pattern.

Relative Strength: The stock should exhibit relative strength compared to the overall market, ideally outperforming its peers and the broader indices.

Accumulation: Analyze trading volume during the base formation. Accumulation by institutional investors is a positive sign, so look for days with above-average volume and strong price action.

Mark Minervini, a renowned stock trader, refers to some pivot points as “cheats” and “low cheats.” Some traders also refer to these as “alternative pivots”. These are resistance levels that, when broken, can signal a breakout and an optimal time to enter a trade. Minervini coined these terms because instead of waiting for the base breakout (primary pivot), he would cheat and buy early, spotting these structural trends and getting a better price on his position. To use pivot points effectively:

Identify the Pivot: Determine the location of the pivot point within the base. Low cheats occur in the lower portion of the base when the stock is first starting to turn up. These offer higher rewards because you can get in earlier in the trend, but they often involve higher risk, as the trend is not yet established. Cheats, on the other hand, occur halfway up the base and offer a more reasonable risk-reward ratio. The pivot point is typically a key level from the left side of the base or a breakout point from consolidation.

Buy on the Breakout: When the stock’s price breaks above the pivot point on higher-than-average volume, it signals a potential breakout, and you can enter a long position.

Set Stop-Loss Orders: To manage risk, set a stop-loss order below the pivot point or a predetermined percentage below your entry point.

By understanding and learning to identify alternative pivots, you can better determine the appropriate pivot point for your trade and balance risk and reward. This will help you maximize your chances of success while employing strong risk management principles.

Buying earnings winners in structural bases, such as the cup-with-handle pattern, can be a powerful trading strategy for capturing gains. By recognizing the characteristics of this pattern, identifying stocks building the right side of their bases after a strong earnings reaction, and using pivot points as entry levels, you can maximize your chances of success. As always, practice strong risk management principles to ensure long-term success in the stock market.