Gold forms bullish cup & handle pattern

With its latest pullback gold has traced out a potentially bullish cup and handle pattern which could send the yellow metal to $2,070 an ounce.

In his latest article Jim Willie CB, author of the Hat Trick Letter, draws our attention to a potentially bullish chart pattern that has formed in gold.

The Gold price has been doing important technical work for the last month. On the surface the price movement looks boring if not weak, with lost momentum. That is typical of the brief phase when consolidation takes place, while building the right side handle. The downside risk is to 1720 (daily basis) or 1750 (weekly basis), really no big deal. The recently announced and detailed QE3 initiative is incredibly bullish for Gold, providing the bull market the most wonderful fuel that is supercharged by the permanent 0% rate.”

The cap and handle pattern

The cup and handle pattern is a bullish continuation pattern that marks a period of consolidation which is typically followed by a breakout.

Originally developed by William O’Neil and introduced in his 1988 book, How to Make Money in Stocks, the cup and handle pattern consists of two parts: the cup and the handle.

The cup, which forms after an advance, looks like a bowl or rounding bottom formation. When the cup is completed, a downward sloping trading range develops on the right hand side forming the handle. A breakout from the handle’s trading range signals a continuation of the prior uptrend.

As stockcharts.com explains, “The handle represents the final consolidation/ pullback before the big breakout and can retrace up to 1/3 of the cup’s advance, but usually not more. The smaller the retracement, the more bullish the formation and significant the breakout.”

As the chart below shows, gold has traced out just such a pattern.

From its 28 February peak of $1,792, gold fell all the way to $1,526, before rising to $1,798 on 5 October. Since then gold has pulled back to around $1,730, and in doing so it has begun to form the handle.  The handle can last for many weeks but should ideally complete within 1-4 weeks.

A 1 year chart of Gold (Click on the chart for a larger version)

A 1 year chart of Gold

Chart courtesy of stockcharts.com

An advance and subsequent breakout above the blue horizontal line at around $1,800 would likely propel gold to a target price of $2,070. The target price is calculated by measuring the distance from the bottom of the cup to its right hand peak and adding it to the breakout price level.

The breakout should be confirmed by a spike in volume. A move into positive territory by the Chaikin Money Flow (CMF) indicator would also help confirm a breakout.

The Chaikin Money Flow (CMF) indicator

The Chaikin Money Flow (CMF) indicator fluctuates between -1 and +1, however it rarely reaches these extremes since it would require twenty consecutive closes on the high (or low) for the 20-day CMF to reach +1 (or -1). Typically it fluctuates between -.50 and +.50 with zero as the centreline.

As stockcharts.com explains, the CMF indicatormeasures buying and selling pressure for a given period of time. A move into positive territory indicates buying pressure, while a move into negative territory indicates selling pressure. Chartists can use the absolute value of Chaikin Money Flow to confirm or question the price action of the underlying. Positive CMF would confirm an uptrend, but negative CMF would call into question the strength behind an uptrend. The reverse holds true for downtrends.”

Playing the breakout

Those looking to play the breakout in gold should wait for it to break above the blue horizontal resistance line at around $1,800. A strong close above $1,810 would be very bullish for gold, particularly if it were to occur on strong volume. This would likely trigger strong buying that would quickly propel it towards the nominal all-time high of $1,923.70 where it will likely encounter some resistance. Once clear of $1,923 I expect gold to advance quickly towards $2,000 an ounce.

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