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Monday, May 20, 2013

Bullish and bearish flags



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:

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.



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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.