Price patterns are a cornerstone of technical analysis. They repeatedly appear in the market, generate early signals, and are relatively easy to spot. As they emerge on all timeframes and various markets, may therefore be applied by day traders, swing traders, position traders, and investors.
Flag pattern is among the top 10 most popular chart patterns that occur regularly within the financial markets. In this article we will get into what a flag pattern is, what it looks like, how to read it, and what is the market psychology behind it.
How to Trade the Flag Pattern – Quick Guide
- Learn the principles of technical trading at NAGA Academy.
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What is a Flag Pattern and How to Spot It
A flag pattern is a continuation price pattern which may occur across varying timeframes in financial markets. This pattern emerges when there's a sharp price rise or decline (the flagpole), which is followed by a small price range or correction (“the flag”). Technical traders refer to flags as continuation patterns since they typically appear before the trend that preceded their development resumes.
For illustrative purposes only
Since a flag pattern indicates a strong trend that is likely to persist, traders rely on them to spot potential trading opportunities. There are primarily two types of flag patterns: the bull flag and the bear flag. A significant upward price movement may be accompanied by a bull flag pattern, while a significant downward price movement may be then followed by a bear flag pattern.
How to Spot a Flag Pattern
A flag pattern is basically an area where the price shows a countertrend or a tight range that occurs right after a significant price directional movement. These patterns can be preceded both by an ascending trend (bull flag) or a descending one (bear flag).
A valid flag pattern has 4 distinct characteristics:
The flagpole
The bull flag is characterized by a strong momentum during the flagpole phase, while a bearish flag pattern usually tends to maintain intensity during the whole progress of the pattern, as downtrends are usually move faster due to the underlying fear and anxiety.
The flag
The consolidation, or the range, which is defined as the flag, is a slow price movement after an aggressive rise or drop. It could take the shape of a price channel, if the lines are equidistant, or a wedge or pennant, if the lines are converging.
The volume
Along with price fluctuations, a flag pattern is also characterized by volume variations. Volume will typically rise in a flag pattern during the initial trend and fall or remain flat during the consolidation phase.
The Breakout
When price breaks out of the confining trendlines, the pattern is complete. Within a valid flag pattern, the price breaks out of the consolidation period in the same direction as the preceding trend.
Flag patterns are typically seen as an integrated stage in the market, characterized by a balance between buyers and sellers. This phase lacks an obvious trend direction. When a flag pattern occurs, traders search for specific price levels, where the price has bounced back several times, creating support and resistance areas. To trade a flag pattern, seasoned traders are usually waiting for the breakout, which happens when the price escapes the flag range. This may provide them with clear entry and exist points as well as stop loss and price targets.
Learn more about Chart Patterns
What is a Bull Flag?
If you are a technical trader, bull flag might be a great pattern to have in your arsenal. A bullish flag, also known as a rising flag pattern, occurs after a significant upward price movement and is distinguished by a period of consolidation in which the price falls slightly lower. This shows that buyers are more enthusiast than sellers, signaling that momentum is still favorable for the asset.
The pattern begins with a strong, nearly vertical price surge, followed by a sluggish downward consolidation that looks like a sloping channel or rectangle with two parallel trendlines against the previous trend, characterized by a decreasing volume.
What does a bull flag look like
If you are willing to integrate the bull flag pattern into your trading strategy, you need to develop the sense to recognize its shape. Here is how a bullish flag looks like:
For illustrative purposes only. Past performance is not indicative of future results.
A bull flag pattern breakout above the upper trendline is a signal that the bullish trend is expected to continue. The bull flag's strength increases according to the sharpness of its flagpole spike. During a rising flag pattern, bulls are more enthusiasts than bears and this is what price action reflects.
Spotting a bull flag in real time is the most difficult aspect of this price pattern. A rise in supply interrupts price surge and fluctuating prices generates a bullish flag pattern. When demand exceeds supply, the price breaks flag's resistance and trend resumes.
What is a Bear Flag Pattern?
A bear flag is a price pattern that indicates a bearish continuation of an existing descending trend. Pattern's formation is emphasized by an initial strong downtrend, followed by a consolidation, during which the price moves sideways or slightly higher. The strong downward movement represents the 'flagpole,' while the consolidation phase is commonly referred to as the 'flag' itself.
The flagpole is formed by an almost vertical panic price drop that occurred unexpectedly and the flag's formation by the bounce of the price along parallel upper and lower trend lines. The strength of the bearish flag pattern is determined by the magnitude of the drop on the flagpole. Due to some profit-taking, the initial sell-off ends, creating a narrow price channel, with slightly higher highs and lows.
For illustrative purposes only. Past performance is not indicative of future results.
When a bearish flag develops on a chart, traders look for high or rising volume into the flagpole, or the trend that emerges before the flag. The downtrend (flagpole) accompanied by an increasing or higher-than-usual volume signals an stronger enthusiasm on the supply side for the security.
The volume, which denotes a consolidation and gradual retreat from the downtrend, should be low or dropping. This indicates a decreased level of enthusiasm during the consolidation phase.
The overall momentum in the market appears to be negative given the high volume into the move lower (flagpole) and the low volume during the consolidation. This strengthens the hypothesis that the previous descending trend is probably going to continue.
How to Trade Bull Flag & Bear Flag Patterns
As soon as you spot a flag pattern, you can trade it using derivatives such as CFDs. Because you do not own the underlying asset when you trade derivatives, you may go both long (buy), or short (sell). This allows you to speculate on price swings, which may allow you to trade both the bull flag pattern and the bear flag pattern.
Bear and bull flag are useful trading patterns that might reveal potential trading opportunities.
Using pattern's basic principles, traders can develop a flag pattern trading strategy by identifying three crucial points: entrance, stop loss, and profit target.
- Spot the flag pattern: Seek for a sudden price surge or decline (flagpole) that is followed by a consolidation phase (flag) between support and resistance lines sloping down, during a bullish trend, or up, during a bearish trend.
- Define the entry point: Although a flag pattern signals a continuation of the current trend, it is preferable to wait for the breakout to avoid a potential false signal. A breakout accompanied by an increased volume indicates a strong force behind the move, pushing the price out of the flag and that price direction is more likely to be maintained.
- Place a Stop Loss: The opposite side of the flag pattern is what traders usually aim to use as their stop loss. This means that when you are trading a bull flag, the stop-loss level would be placed below flag's support line, while for a bearish flag, would be above resistance line. It is up your risk tolerance how tight or large stop loss is.
- Set a profit target: Though there is consensus among professionals over an entrance point, the profit target is debatable. Some traders may determine a profit target based on the flagpole's height, while a more conservative trader would take the distance between the support and the resistance of the flag and multiply it by two for his profit target.
Beside these primary four criteria, traders can optimize their flag patterns trading strategy by carefully defining the position size and the risk reward ratio for each trade. When entering a trade, traders should constantly keep an eye on it making sure the price keeps moving in the breakout's direction. When a transaction goes well, a trader may also use a trailing stop or move his stop loss above the breakeven point to lock in profits.
In addition to that, it is crucial to have a well-defined trading plan, a healthy risk and money management approach, and discipline to execute a flag pattern trading strategy effectively.
Bull Flag vs Bear Flag
The bull flag and bear flag patterns are both continuation patterns that traders may encounter in the market. Although their structure and development process are identical, the two patterns differ significantly.
Their directional implications are where they differ the most. After a consolidation period, a bull flag indicates the resume of the initial upward trend, suggesting that buyers are gathering strength and getting ready for a further surge. On the other hand, the bearish flag pattern, which is also a continuation pattern, signals the downward trend is continuing and that sellers are taking back control, indicating that price is probably going to drop lower.
The flag formation's slope is another obvious distinction. In a bull flag pattern, the flag shifts sideways or downward, whereas a bear flag pattern has parallel lines slopping upward. These divergent slopes show the market’s temporary equilibrium or pause before the price moves ahead in the dominant direction.
Bull Flag
Bear Flag
- The flagpole is an uptrend
- The flag is a range or a lower correction
- Price breaks the resistance line of the flag
- The flagpole is a downtrend
- The flag is a range or a higher correction
- Price breaks the support line of the flag
How to Get Started with NAGA.com
- Open a trading account: To get started with flag pattern trading, open an account with us. Choose between a live account to trade CFDs straight away, or practice first on our demo account with virtual funds.
- Choose your financial instrument: Flag patterns can be spotted in most financial markets, especially those that are more dynamic, such as forex, cryptocurrencies, and stocks.
- Explore our trading platform: We offer multiple chart types, as well as a range of order execution tools for fast trading, which in turn helps you to manage risk.
Flag Pattern Trading Summed Up
The flag pattern is a popular technical analysis tool that can help traders to predict and prepare in advance for a bullish or bearish entry. A bullish flag pattern implies a strong rally and a potential buying opportunity following the bullish breakout of a descending channel. On the other hand, the bear flag pattern suggests a severe downturn, thus a bearish breakout of the bear flag can be an opportunity to short sell the asset.
Trading in financial markets involves risks and markets may react unfavorably to different factors. To properly navigate through different market conditions, traders must first understand how to trade a flag pattern breakout, how market sensibility may affect their positions, and the crucial importance of risk management.
As a trader, try to approach the markets with diligence, self-control, and confidence as you trade the flag patterns. Keep an eye on potential opportunities, but never forget about the risks.
Free resources
Before you start trading chart patterns, you should consider using the educational resources we offer like NAGA Academy or a demo trading account. NAGA Academy has lots of free trading courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader or make more-informed investment decisions.
Our demo account is a suitable place for you to get an intimate understanding of how trading and investing work – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for investors who are looking to make a transition to leveraged securities.
Sources:
https://chartpatterns.com/
https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/technical-analysis
https://research.stlouisfed.org/wp/more/2011-001
