A flag pattern is a term you will come across in technical analysis. It is a pattern that forms whenever there is a sharp rise or drop which is followed by a constricted price range trading, and then finally completed by another sharp rise or decline.
The pattern is considered complete when the second sharp movement of price maintains the same direction as the first move, which kickstarted the trend, as mentioned above. Flag patterns are short-term patterns lasting some weeks.
How does a flag look like?
– The flag chart has a body and a flag pole.
– The body is a rectangular shape which is formed by two lines that are parallel to each other. The rectangle is connected to the flagpole, which is a quick and large move.
If you have been interested in flag charts, you will also notice that another term called pennant is often used interchangeably. However, there’s a slight difference between a flag and a pennant. The mid section of a pennant has trendlines that converge whereas in a flag, the mid section has no trendline convergence.
Bull and bear flags
There are bullish flag patterns and bearish flag chart patterns. A bullish flag chart pattern occurs in the time of an uptrend, and signals that there may be a continuation of the uptrend. On the other hand, a bearish flag chart pattern in trading forms during a downtrend. It signifies the likelihood of a bearish trend continuing.
The flag pattern is characterised by five elements: the trend that is preceding it, the consolidation channel, volume pattern, breakout, and confirmation in which the price movement is in the same direction as the breakout.
Trading the flag pattern
The bull flag, as it occurs during an uptrend, underlines a consolidation that is slow and lower following a strong move towards the higher side. This means there is greater enthusiasm to buy on the move upwards than on the move downwards. If you wish to trade the bull flag, you may wait for price to break out over consolidation resistance so that you can seek an entry (long). The breakout means the trend before its formation is in continuation.
A bear flag chart pattern, which looks like a bull flag has been inverted, occurs in a downtrend as suggested earlier. In such a scenario, the bear flag reflects a consolidation tha is slow and higher following a strong move on the lower side. The meaning of this is that there is more enthusiasm to sell on the move downwards than upwards. The momentum of the security remains negative.
If you wish to trade a bear flag, you may adopt a wait and watch policy till the price breaks below the consolidation support so you can find entry (short) into the market.
Keep an eye on volume
– Looking for volume adds one more dimension when you are interested in the flag pattern in trading. If there is no volume alongside the breakouts of any flag pattern, then it means the signal is not a reliable one.
– If you are trading a bear flag pattern, you would want to see a growing volume into the pole, ie, the trend that is before the flag. The rising volume alongside a downtrend or flagpole would mean a greater enthusiasm on the selling side. In an ideal situation, the flag should have a low volume into it.
– When you are looking at a bull flag pattern in trading, you would wish to see a growing volume into the pole. This would suggest a greater enthusiasm on the buying side. The flag should have lower volume into its formation.
– Also, traders of flag patterns would wish to see breakout alongside a high-volume bar, as it is indicative of a solid force that shifts price into a trend that’s renewed.
On the question of stop loss, traders typically set the side opposite the flag pattern as a stop-loss point.
A flag pattern is among the most widely used chart patterns in trading. The flagpole is indicative of the trend before the flag. The flag is representative of a consolidation after a trend. A flag pattern in trading is a short-term continuation pattern that signifies a tiny consolidation following which the earlier move gets renewed. Traders thus use both bull and bear flag chart patterns to identify continuation of trends.