A flag pattern in technical analysis is a visual representation of short-term price movements that occur within a parallelogram, counter to the previous long-term trend. Traditional analysts consider flags to be potential indicators of trend continuation.
There are two types of flag patterns: bull flags and bear flags. Although they have different outcomes, both types of flags exhibit five key characteristics:
1. A strong preceding trend, also known as the flagpole or pole.
2. The consolidation channel, which is the flag itself.
3. The trading volume pattern.
4. A breakout.
5. A confirmation of the price moving in the direction of its previous trend.
In this article, we will discuss bull and bear flag patterns and how to trade them.
What is a bull flag pattern?
A bull flag is a technical pattern that occurs when the price consolidates lower within a downward-sloping channel after a strong uptrend. This channel is formed by two parallel, rising trendlines. It is important to note that if the trendlines converge, the pattern could be a wedge or a pennant.
During the consolidation phase, the trading volume typically decreases, indicating that traders associated with the preceding trend are less urgent to buy or sell.
When the price breaks above the upper trendline of the bull flag, trading volumes usually increase as new and old investors feel the urge to jump in, driven by the fear of missing out (FOMO).
Analysts consider strong volumes during a bull flag breakout as a sign of a successful continuation of the bullish trend. However, if the price breaks above the upper trendline with lackluster volumes, there is a higher possibility of a fakeout. In other words, the price may drop below the upper trendline, invalidating the bullish setup.
Trading a bull flag setup
Traders can enter a long position at the bottom of a bull flag, anticipating that the price will break out towards the upper trendline. For those who are more risk-averse, it is advisable to wait for a breakout confirmation before opening a long position.
As for the upside target, a bull flag breakout typically leads to a price increase of approximately the same size as the flagpole, measured from the bottom of the flag.
The following example is a Bitcoin (BTC) price pattern between December 2020 and February 2021, demonstrating a successful bull flag breakout setup.
It is important for traders to manage their risks by placing a stop loss just below their entry levels. This allows them to limit their losses if the bull flag pattern is invalidated.
What is a bear flag pattern?
A bear flag pattern is the opposite of a bull flag pattern. It occurs when the price initially moves downwards, followed by an upward consolidation within a parallel channel. The downward move is referred to as the flagpole, while the upward consolidation channel is known as the bear flag.
During the formation of a bear flag, trading volumes usually decline.
Trading a bear flag pattern
The following example illustrates how to trade a bear flag pattern on crypto charts.
In the Bitcoin chart above, the price forms a flagpole followed by an upward retracement within a rising parallel channel. Eventually, the price breaks out of the channel range to the downside, dropping by approximately the same height as the flagpole.
Traders can choose to open a short position on a pullback from the upper trendline of the flag or wait until the price breaks below the lower trendline with increasing volumes.
In either case, the target for the short position is typically determined by subtracting the peak of the flag from the size of the flagpole.
If the price breaks below the lower trendline of the flag with lackluster volumes, it suggests a fakeout, indicating that the price may reclaim the lower trendline as support for a potential rebound within the parallel channel.
To minimize losses in a fakeout scenario, it is crucial to place a stop loss just above the entry levels.
This article does not provide investment advice or recommendations. Every investment and trading decision carries risks, and readers should conduct their own research before making any decisions.