A Cup of Hot Chocolate

Cup and handle formations, if formed correctly, are potentially a very powerful bullish continuation patterns. They start as a consolidation period in an uptrend followed by a breakout to new highs. As its name implies, there are two parts to the pattern: the cup and the handle. The cup forms after an advance and takes the shape of a bowl or a U. As the cup is completed, price is rejected at or near prior highs, a trading range develops on the right hand side and forms the handle. A subsequent breakout from the handle's trading range signals a continuation of the prior advance. During the formation, you would ideally 1) like the handle to not move lower than 50% of the depth of the cup; 2) see volume decreases during formation of the handle and 3) volume increase on its breakout.

After making new highs in October 2014 from the breakout of a 2013 W-bottom, cocoa is currently in the process of forming a very nice cup and handle pattern and the potential for an intriguing investment opportunity. It is never wise to jump ahead and project that a pattern in development is going to actually complete. First off patterns don’t always complete, even those with the best setups and secondly the little bit you gain in getting in early before its completion is not worth the risk if the pattern fails. I find waiting for the additional confirmation greatly increases your success rate. In addition to the pattern setup, notice how right now price is above the faster moving average which is above the slower moving average which is pointing up.  This bullish alignment is confirmation we are in an uptrend and is exactly the setup we would like to see before we enter any long position, not just cocoa.

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If Cocoa decides to actually follow through and complete the cup and handle by breaking above the rim of the cup (red horizontal line), the opportunity is quite attractive as the pattern projects to a 25% increase over the coming months.