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Thomas Bulkowski’s successful investment activities allowed him to retire at age 36. He is an internationally known author and trader with 30+ years of stock market experience and widely regarded as a leading expert on chart patterns. He may be reached at

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Bulkowski’s Cups and Caps

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In my book, Swing and Day TradingSwing and Day Trading: Evolution of a Trader book., shown on the left, I discuss "The Three-Bar Net Line Setup" starting on page 17. It includes performance tests.

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This article discusses Joseph Stowell's cups, caps and the three bar net line as a position trading setup.

Cups and Caps Summary

This trading setup results in some good performance numbers on the weekly scale (16.2% to 24.5% average gain per trade) but trades are few. Drawdowns can be a problem (13% to 24%) if you're not willing to hold onto the position until a sell signal appears. That's typical for systems that use weekly data.

I included a simple moving average to eliminate losing trades that occurred in a bear market. The 15 and 20-week SMAs seemed to work best, but the 10 week SMA also did well.

Be sure to test this setup yourself since implementation can be difficult. You may want to test only the three-bar net line for entry and exit signals instead of the complete system with cups and caps. In one test I ran, it showed promise.

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Cups and Caps Background

Technical Analysis of Stocks & Commodities magazine interviewed Joseph Stowell in the July 1995 issue and included a sidebar on the three bar net line, cups, and caps. He says, "I use what I call a three-bar net line that I use to identify the medium-term trend in the bond market. It's an excellent device to use on a monthly stock chart." He goes on to explain that when the monthly price retraces back to the three-bar net line, "it's an excellent place to purchase [the stock]."

I decided to test the three-bar net line along with his cups and caps entry and exit signals on the daily and weekly charts, not the monthly scale.

Cups and Caps Methodology

I used 559 stocks and 104 exchange traded funds from March 12, 2001 to October 1, 2010. Those two dates have the S&P 500 index beginning and ending near the same price. In between those two dates, the market experienced two bull and two bear markets. Not all securities covered the entire range. I also made a few runs with data going back to 1990.

I used the following rules.

  • Excluded any security at the time of purchase if it had a low price of $5 or below.
  • Commissions per trade were $10 ($20 round trip).
  • Invest $10,000 per trade.

Begin looking for the setup by determining the price trend. Use higher highs and higher lows for an up trend and lower highs and lower lows for a down trend.

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The Three Bar Net Line

Picture of the three bar net line for up and down trends.

Once you have determined the initial trend in your data series, look for the three-bar net line. The figure shows a hypothetical example.

The image on the right is for price up trends. Here are the rules for up trends.

  • Price must be making higher highs and higher lows (trending up).
  • Point 1 is the highest high in the trend
  • Point 2 is the prior low that is equal to or below the low at point 1.
  • Point 3 is the prior low that is equal to or below the low at point 2.
  • The trend changes from up to down when price closes below the low at 3. I show that as a red line. It is the three-bar net line.
  • If price makes a new high or equals the current high, then recalculate the three-bar net line.
  • The trend is considered to be up if price does not close below the three-bar net line.

Picture of the three bar net line for up and down trends.

The next image on the right is for price down trends. Here are the rules.

  • Price must be making lower highs and lower lows (trending down).
  • Point 1 is the lowest low in the trend
  • Point 2 is the prior high that is equal to or above the high at point 1.
  • Point 3 is the prior high that is equal to or above the high at point 2.
  • The trend changes from down to up when price closes above the high at 3. I show that as a red line. It is the three-bar net line.
  • If price makes a new low or equals the current low, then recalculate the three-bar net line.
  • The trend is considered to be down if price does not close above the three-bar net line.

These two patterns determine the price trend leading to cups and caps.

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Cups and Caps

After determining the trend using the three-bar net line as described above, then look for a cup or cap trading signal. The cup and cap patterns are highlighted in red boxes in the figure.

Cups appear in an up trend and I show an example of that in the figure. Here are the rules for a cup sell signal.

Picture of the cups and caps pattern.

  • Price is trending up as determined by the three-bar net line.
  • Use three consecutive closes or lows. I used lows.
  • The middle bar must be the lowest low (or lowest close) of the three bars.
  • The cup must appear at the highest high of the current trend. I used the highest price of the three bar pattern.
  • Sell when price closes 3 cents below the cup's middle bar (below the lowest low of the three bar cup).

Caps follow similar rules, but issue buy signals.

  • Price is trending down as determined by the three-bar net line.
  • Use three consecutive closes or highs. I used highs.
  • The middle bar must be the highest high (or highest close) of the three bars.
  • The cap must appear at the lowest low of the current trend. I used the lowest price of the three bar pattern.
  • Buy when price closes 3 cents above the cap's middle bar (above the highest high of the three bar cap).
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Trading Setup

The setup to buy a stock or exchange traded fund followed these rules and they depend on the three-bar net line and cap pattern as described above.

  • Buy when price closes above the three-bar net line providing...
  • *A cap pattern appears at the bottom of the downtrend, and
  • The buy signal occurs within three bars.
  • The buy stop price is three cents above the cap high.
  • Use the buy stop price or the opening price in case of price gaps.

The sell signal is given by these rules and it also includes the three-bar net line and cup pattern as described above.

  • Sell when price closes below the three-bar net line providing...
  • *A cup pattern appears at the top of the up trend, and
  • The sell signal occurs within three bars.
  • The sell price is three cents below the cup low.
  • Use the sell price or the opening price in case of price gaps.

* The rule regarding the cup or cap appearing at the end of a trend can be difficult to automate for testing, but do your best. My method is somewhat complicated. I found the highest high or lowest low before the three-bar net line to the cup or cap. You may want to be sure that the cup or cap is the lowest low or highest high of the past x bars for simplicity.

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Cups and Caps Results

The following table shows all of the tests that I ran using this setup, sorted by the average gain (second column on the left).

Win
Loss
Avg
Gain
Avg Max
Drawdown
Hold Time
Loss
 S&P Hold Time
Days
TradesSMADescription
41%1.0%5.8%3.7%-1.1%401768N/A88 long only ETFs with stop
below cap, daily
58%1.7%10.5%8.6%-1.7%851435N/A104 ETFs, daily
60%2.0%9.9%8.2%-1.5%841306N/A88 long only ETFs, daily
40%2.7%10.0%6.1%-1.3%529468N/A559 stocks with stop below cap, daily
64%3.1%8.1%6.5%-0.9%82907100 day88 long only ETFs, daily
61%5.3%15.8%12.3%-1.8%118437350 day559 stocks, daily
61%5.3%16.8%13.0%-1.7%1206736N/A559 stocks, daily
74%16.2%17.5%13.6%1.4%40920710 week104 ETFs from 1990, weekly
68%17.3%24.4%20.2%0.7%414113910 week559 stocks, weekly
81%21.4%14.3%12.1%5.1%41713810 week88 long only ETFs, weekly
84%23.8%13.7%10.3%5.8%41212720 week88 long only ETFs, weekly
83%24.5%13.9%10.9%6.7%43112615 week88 long only ETFs, weekly

The first test includes a stop loss placed below the cap (the cap signals a buy in a down trend). The reason for this test is that there were a number of large losses and I wanted to see if using a stop would cut their size. The average gain was the worst of the bunch, but it did cut the maximum drawdown per trade, averaged over all trades (shown as Avg Max Drawdown) and it also cut the hold time loss.

The hold time loss is how far price drops below the buy price during the trade, averaged over all trades.

The daily or weekly phrases in the description refer to daily or weekly price data used in the test.

Looking at the some of the test results, I decided to add a moving average to filter out trades in a bear market. I tried various values as the table shows. Including a moving average tended to boost the win/loss ratio and the average gain, but the drawdown and hold time loss also increased.

Notice that the higher the average gain, the fewer trades completed. Thus, don't look for huge gains or high win/loss ratios with the setup when using the 10-week to 20-week simple moving averages (SMA).

Since the trade count was so low, I tested the same setup using 559 stocks (4th row from the bottom versus 3rd row from bottom) and found that the win/loss ratio dropped from 81% to 68% and the average gain dropped from 21.4% to 17.3% using almost ten times the number of trades. Thus, the larger trade count gives more realistic results.

If you realize that a 10-week moving average is the same as a 50 day SMA, then you get four times the number of trades. The win/loss ratio remains close (68% versus 61%) but the average gain plummets from 17.3% to 5.3%. The drawdown drops (which is good), however. Thus, this setup works best on the weekly scale (using weekly data) providing you can keep the drawdown in check.

Adjusting some of the setup conditions may improve performance and increase the number of trades. You might use only the three-bar net line as an entry and exit signal and forget about cups and caps.

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Cups and Caps Example

Picture of the Dow utilities on the weekly scale.

As an example of the cup and cap system, I show a picture of the Dow Utilities on the weekly scale. At point A begins the red box inset which shows the three bar net line for up and downtrends. Points 1, 2, and 3 correspond to the three-bar net line in an uptrend. However, price closes below the three-bar net line, flipping the trend to downward. That happens at the phrase "Trend Down" on the chart.

Following that, points 4, 5, and 6 show a three-bar net line that confirms a trend change from down to up. That occurs at "Trend Up."

A cap pattern appears at the bottom of the down trend, shown in the blue box inset. Thus, we have all of the ingredients of a buy signal except for the 10-period SMA. If you draw in the SMA, you'll find that price is above the SMA, so an entry signal is given on 11/30/2009 at 379.92. I show that as the green line.

For the exit, I only show the cup pattern, but the three-bar net line is the same as the red bar. You can see the three higher lows clustered together in the three days before the sell signal. The sell signal occurs on 11/15/2010 at 398.52 for a gain of $18.60 per share. That's not much considering a drawdown of 12.6% during the trade and a hold time loss of 8.7%.

-- Thomas Bulkowski

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See Also

  • Cups and Caps Trading Setup. Discusses results of the 3-bar net line only.
  • Adam White setup. This setup is good for trading ETFs, and it has a unique dual exit strategy.
  • Cloudbank. For buy-and-hold investors, a cloudbank chart pattern is an easy way to make large profits.
  • Darvas Box setup. This setup is works best using ETFs on the weekly scale: 10.5% in 10 months.
  • Double bottom trading setup. Trades double bottoms and has won 80% of the time over 20 years.
  • Double 7s. This setup is for trading ETFs and it has a high win/loss ratio but little profits.

Written by and copyright © 2005-2017 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. You never know how many friends you have until you rent a house on the beach.