This week I started a series of articles on chart
patterns and I discussed a wedge pattern on Wednesday. Today I want to continue
the topic and talk about flag technical patterns. I hope that you learned
something from previous post and I expect you to learn from this one even more.
Flags are among my favorite patterns and when I recognize them in the charts I
start preparing for a big move as these often result in strong breakouts and
consequently nice money (if I jump into a trade). So, let us look what flags
are and how you can trade them.
Some tend to put flags and pennants into the same
category, but I do not want to confuse you and therefore I will analyze
pennants separately in my next post.
I also suggest you read other articles on the topic and watch a video on how you can trade flags:
I also suggest you read other articles on the topic and watch a video on how you can trade flags:
The video:
What
is a flag pattern?
It is a trend continuation pattern that can be on
various time frames and may last from a few days to a few months. It is
rectangular in shape and can be formed in various angles. A flag indicates that
a security is in consolidation pattern and market is searching for direction.
Most often than not, when the pattern is broken the price will move in the
direction of the prevailing trend. Flags are often formed after a very sharp
advancement of prices and appearance of a flag merely indicates that the market
is in the state of ‘rest’.
Now, the initial move from previous consolidation or
range to the top of the flag is often called the flagpole. For a pattern to be
valid there has to be another breakout of the pattern in the same direction as
the previous one. We already know that the pattern is in the shape of a
rectangle. The rectangle is ‘caged’ by two trendlines (upper and lower). They
might be more or less horizontal (flat) or falling (if the flag is bullish).
That is not very important. What important is that the pattern should be
followed by continuation of a previous move. (Of course, it is better when the
trendlines that act as support and resistance would be slopping, not entirely
flat).
Bullish structure
Bullish flag is a bullish chart pattern that usually
results in an upward breakout of the pattern. It is formed after a strong move
upwards and indicates that prices are consolidating before another move up.
The example above shows us two examples of bullish
flags in gbp/jpy currency pair. As you may know Japanese Yen has been in a strong downtrend for quite a
long period of time. Pound has been very strong against Yen. So, the first
example shows us a bullish flag that was formed and broken in one week (from
19-12-2012 to 26-12-2012). After a breakout the pair rallied for about 600
pips. It formed a small bullish pennant in the middle of the move, but let us
not concentrate on that today.
After the move stalled the second bullish flag
started to form. The second flag wasn’t really longer in terms of time than the
first one. It started on the 2nd of January, 2013 when the top was
formed and ended with a breakout upwards on the 10th of January,
2013. This move wasn’t as strong as the first one. However, from the breakout
point the pair rallied around 350 pips. Still nice move, huh?
How
to trade it
Coming back to the chart of gbp/jpy above you can
see the point for long entries on both examples. You go long when the upper
trendline of the flag is broken. So, by knowing this information you must have
your long entry ready before the breakout occurs. In the first case it was
136.84 level (to buy the pair). Market opened with a gap after Christmas, so
you had to readjust your position and enter a long with the first available
price of 137.73. I usually place stop loss order a few pips below the low of
the day market broke the pattern. In this case it was 136.26. Of course, you
had to move your stop as fast as market progressed higher as this initial stop
was kind of big if you are a day trader. It is ok for swing and trend traders
though. What about exits? Nobody can give you the best way to exit the market.
One way is to move your stops below daily candles or 4-8 hour candles, or
support zones or simply calculating the size of the pattern and add the number
to the breakout zone and exit the market when market hits the area. Another
possibility is to exit at even numbers. So, in my opinion it is best to open a
number of trades 3-4 and keep on exiting (at even numbers) as market progresses
upwards.
Follow the same procedure with the second pattern to
find out the best entry, stop loss and exit areas. Let it be your homework. You
will be surprised how much you can learn from such a simple exercise as this.
Bearish
flag formation
Bearish flag is a bearish chart pattern that usually
results in a downward breakout of the pattern. It is formed after a strong move
down and indicates that prices are consolidating before another move down.
The example above shows us two examples of bearish
flags in Gold (XAU/USD). The first bearish flag formed from the 5th
of April (2013) to the 10th of April (2013) when the pattern was
broken. After the breakout down gold collapsed more than 160 dollars per ounce.
Wow! It then regained some of what it has lost, but the gains were short lived
and the commodity started going down after some horizontal range trading. On
the 10th of May it broke the horizontal channel and formed a bearish
flag in a period of four days. On the 15th of May Gold broke out of
its’ bearish flag pattern and collapsed around 80 bucks per ounce. Nice move,
huh?
How
to trade a bearish pattern
We have to reverse the process of how we trade a
bullish flag. We have to trade a break of a lower trendline of the flag. If you
look at the first example you can clearly see that the break came at around
1576 level. Depending on your trading style you could have place your stop loss
above 4 hour candle (1583) when the breakout occurred. Alternatively, you could
have placed your stop above the highest point of the flag, which was 1591. Now,
if you are not very patient you still would have got a very good risk reward
ratio by simply waiting and placing your stop above daily candles and when 1540
level was broken you would have stayed till the end of the move by simply
moving your stop above 4 hour candle. Check it out for yourselves.
Follow the same drill to find out how you should
have traded the second bearish flag pattern in Gold. Let it be your homework assignment.
Do it to make your trading better.
Ok, I will finish now. Be sure to read related
articles to learn more on technical analysis. I promise to expand on this in my
future posts.
I hope you benefited from the post. If you liked the
post I would also be happy if you gave a plus on Google+, tweeted, liked it on
Facebook and other social platforms. Have a nice day.
Vytas.
Disclaimer
Trading
financial markets carries a high level of risk, and may not be suitable for all
investors. All information on the blog http://trend0.blogspot.com/ is of educational
nature and cannot be considered as advice, recommendation or signals to trade
in any financial markets.