Flag Definition

What is a flag?

In the context of technical analysis, an indicator is a price pattern that in a shorter time frame goes against the prevailing price trend seen in a longer time frame on a price chart . It is named because of how it reminds the viewer of a flag on a pole.

The flag pattern is used to identify the possible continuation of a previous trend from a point at which price has drifted against that same trend. Should the trend resume, the price increase could be rapid, making the timing of a trade advantageous by noticing the flag pattern.

Key points to remember

  • A flag pattern, in technical analysis, is a price chart characterized by a strong countertrend (the flag) succeeding a short-lived trend (the flagpole).
  • The flag patterns are accompanied by representative volume indicators as well as price action.
  • Flag patterns signify trend reversals or breakouts after a period of consolidation.

How a Flag Pattern Works

Flags are narrow areas consolidation in price action showing a countertrend move that directly follows a pronounced directional price move. The pattern usually consists of five to twenty price bars. Flag patterns can be up (bull flag) or down (bearish flag). The bottom of the flag must not exceed the middle of the mast which preceded it. Flag patterns have five main characteristics:

  1. The previous trend
  2. The Consolidation Channel
  3. The volume model
  4. Escape
  5. A confirmation where the price moves in the same direction as the breakout

Bullish and bearish patterns have similar structures but differ in trend direction and subtle differences in volume pattern. The bullish volume pattern increases in the previous trend and decreases in the consolidation. In contrast, a bearish volume pattern first increases and then tends to hold, as downtrends tend to increase in volume over time.

The pattern of a flag is also characterized by parallel markers on the consolidation area. If the lines converge, the patterns are called a corner Where pennant pattern. These patterns are some of the most reliable continuation patterns that traders use because they generate a setup to enter an existing trend that is ready to continue. These formations are all similar and tend to appear in similar situations in an existing trend.

The patterns also follow the same volume and breakout patterns. Patterns are characterized by a decrease in trading volume after an initial increase. This implies that traders pushing the prevailing trend have less urgency to continue buying or selling during the consolidation period, creating the possibility that new traders and investors will enthusiastically embrace the trend, driving prices to a higher level. faster pace than usual. .

Flag Pattern Examples

In this bull flag pattern example, the price action rises during the initial trend move and then declines into the consolidation zone. The breakout may not always have a big increase in volume, but analysts and traders prefer to see one because it implies that investors and other traders have entered the stock in a new wave of excitement.

Image by Sabrina Jiang © Investopedia 2020

In a bearish flag pattern, volume does not always decline during consolidation. The reason for this is that bearish and downward price movements are usually driven by investors’ fear and anxiety of falling prices. The lower the prices, the more the remaining investors feel the urgency to act.

Thus, these moves are characterized by above-average (and increasing) volume patterns. When price breaks its downward march, rising volume may not decrease, but rather hold at a level, implying a pause in anxiety levels. Since volume levels are already high, the downside breakout may not be as sharp as the upside breakout in a bullish pattern.

Image by Sabrina Jiang © Investopedia 2020

How to trade a flag pattern

Using the momentum of the flag pattern, a trader can strategize how to trade such patterns by simply identifying three key points: entry, stop loss, and profit target.

  1. Hall: Even though the flags suggest a continuation of the current trend, it is prudent to wait for the initial breakout to avoid a false signal. Traders typically expect to enter a flag the day after price breaks and closes above (a long position) the upper parallel trend line. In a bearish pattern, the day after the price closes below (short position) the lower parallel trend line.
  2. stop loss: Traders generally expect to use the opposite side of the flag pattern as a stop-loss point. For example, if the upper trendline of the pattern is at $55 per share and the lower trendline of the pattern is at $51 per share, then a price level below $51 per share would be a logical place to set the stop loss. order for a long position.
  3. profit target: Conservative traders may want to use the difference, measured in price, between the parallel trendlines of the flag pattern to set a profit target. For example, if there is a difference of $4.00 and the breakout entry point is $55, the trader would place a profit target at $59. A more optimistic approach would be to measure the dollar distance from the top of the model to the bottom of the mast to set a profit target. For example, if the mast low price is $40 and the mast high is $65, and the breakout entry point is $55, then the profit target a trader might expect to see hit would be $80 ($55 plus $25).

In addition to these three key prices, traders should pay close attention to position sizing choices and general market trends to maximize the success of using flag patterns to guide trading strategies.

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