The Flag pattern is a great chart pattern that you MUST add to your forex trading arsenal!
You must have found yourself in this situation…
You waited for a pullback that never came…
The market only moved higher without you…
I know it sucks!
However, you can easily fix this problem.
In this article, I will teach you how to trade the Flag pattern.
What is a Flag Pattern?
The flag pattern is a well-known continuation formation in trading.
It is an on-chart figure that appears as a minor consolidation between impulsive legs of a trend.
Whenever you see this pattern form on a chart, it means that there are high chances of the price action breaking out in the direction of the prevailing trend.
Here are the two criteria that can help you identify the Flag pattern…
1-A strong trending move, normally shown by large body candles.
2-The above is followed by a weak pullback, normally shown by small-bodied candles.
Consider the following example…
The above chart shows that there is a strong trending move which is followed by a weak pullback.
This forms what we call the bullish flag pattern.
The candles in the pullback are small, showing that the pullback is weak.
However, this is not the case with the candles that surround the Flag.
They have larger bodies compared to the ones in the Flag. Note that this is the case with the candles both before and after the Flag.
This shows that the trend is very strong in a bullish direction.
A bearish flag pattern is just the opposite of the above…
It is formed during a bearish move.
It’s shown below…
The chart shows that there is a strong trending move downwards.
The black lines indicate where the bear flag pattern is formed.
These are in a form of a correction directed upwards.
These are pullbacks with small candles.
The small candles are an indication that the pullback is weak.
You should have noticed this…
If the price action is bullish, the Flag is formed in a bearish direction.
And if the price action is bearish, the Flag is formed in a bullish direction.
That’s how it should be!
Now, it will be good for you to know the parts of the Flag pattern.
That’s what you’re about to learn!
Structure of the Flag Pattern
The flag pattern is made up of two parts namely…
- A Flag Pole, and,
- A Flag
The following graphic shows these parts clearly…
The red line in the above graphic is the Flag Pole.
The black channel in the graphic is the Flag.
If you look at the graphic, it looks like a Flag, just like its name.
It is easy for you to recognize this pattern once you know what to look for.
The Flag Pole is the first component of the Flag Chart Pattern.
It shows a trend impulse on the chart.
Any trending move can transition into a flag, meaning that every trend impulse can appear to be a Flag pole.
As the Flag pattern emerges, you will see a large impulse move, commonly known as the Flag Pole.
This is followed by a brief consolidation which takes on the appearance of a Flag.
Once the Flag Pole has been formed, a valid Flag pattern begins to trade within a tight range, forming the shape of a flag.
The Flag has a price action with evenly distributed tops and bottoms.
The price action also brings a corrective character on the graph.
The Flag is angled contrary to the trend impulse that creates the pole.
Flag Pattern Potential
The Flag pattern has a continuation potential on the chart.
This means that a valid Flag pattern is most likely to push the price action further in the same direction as the Flag Pole.
Again, after seeing a Flag formation on your price chart, you will be able to measure the approximate price target on the formation.
The Flag chart figure has two targets…
- Target 1: Size of the Flag
- Target 2: Size of the Pole
These are shown in the following graphic…
Let’s discuss them…
Target 1: Size of the Flag
Once a Flag pattern has been confirmed, you can derive the first target using the measured move technique.
The measured move target is a distance that is equal to the Flag size.
You can measure the Flag size by taking the vertical distance between the upper and the lower channel within a flag.
Note: The distance must be vertical.
You can then apply this distance from the breakout point.
The end of this distance should make your first target.
Later in this article, you’ll see how you should shift the stop loss after attaining these targets.
Target 2: Size of the Pole
The next target of the Flag chart is equal to the size of the Flag Pole.
This means that to get the Target 2, you must measure the vertical distance between the high and the low of the Flag Pole.
After getting the distance, apply it to the pattern.
Again, just as we did with Target 1, this distance should be applied from the start of the breakout point.
The end of this distance should make your Target 2.
When should you Trade the Flag Pattern?
From my experience, there are two times when you should trade the Flag pattern.
After a Market Breakout
Let’s say the market is in a Range and then it breaks down.
Once the market breaks down, the best time for you to trade the Flag pattern is on the first pullback.
When you observe a bearish flag pattern forming, it’s a good time for you to trade the Flag pattern.
Because all traders who miss the move will be waiting for a pullback.
So, you’re sure that once the market pulls back during the formation of the Flag pattern, there are traders who will be looking to short the market since they missed the earlier move.
So, their intention is to catch up with the trend.
That’s why you should consider trading the first pullback or the first flag pattern after the market has just experienced a breakout.
Here is an example…
In the above chart, the Breakout point shows the level at which the market breaks through the resistance.
The first pullback that occurs after that breakout has been shown.
This is not located far from the breakout point.
This is a good time for you to trade!
You notice that after the pullback, the market maintains an upward trend.
The price never went down below that level.
If you had placed a trade during the pullback, you will make profit!
During a Strong Trending Market
Sometimes, the market may show a very strong trending move.
A good example is when it’s trading above the 20-period moving average.
The same market will also show some pullbacks, forming Flag patterns.
These pullbacks give you a nice opportunity to trade the market in the form of a flag pattern.
The following chart shows such a market…
In the above chart, there is a strong price action to the upwards.
Within this trend, there are bull Flag patterns.
These have been marked using the black lines.
They give you a great opportunity to trade the market in the form of a Flag pattern.
If you had bought the currency pair in any of the bull Flags, you would have made profit. The reason is that the price action has maintained an upward trend throughout.
How to Trade the Flag Formation
You now know most characteristics of the Flag pattern.
It’s now time to discuss how you can come up with a winning trading strategy around this setup.
So, let’s go…
The Entry Point
To enter a Flag pattern trade, you should first wait for the confirmation signal.
The confirmation of the Flag comes with a breakout.
If it is a bullish flag, you can buy the currency pair once the price action closes a candle above the upper side.
If it is a bearish Flag, you can sell the currency pair once you see a candle closing below the lower level of the pattern.
Placing the Stop Loss Order
After opening your Flag trade, you should position your stop loss order.
This way, your trade will stay protected from unexpected price moves.
You must consider one basic rule when determining the right place to position your stop loss order for this type of trade.
In case the price reaches the opposite side of the breakout, you should exit the trade immediately.
The reason is that there are high chances that the pattern is false.
The ideal location to place the stop loss is beyond the most extreme swing within the Flag structure.
So, if you have a bullish Flag, place your stop loss order below the lowest bottom in the Flag.
If the price action tries to move below that level, the trade will be closed, and you will be saved from making losses.
If you have a bearish Flag, place your stop loss order above the highest top in the Flag.
If the price action tries to move above that level, the trade will be closed, and you will be saved from making losses.
Flag Pattern Take Profit
To know where and when to take your profit when trading the Flag pattern, consider the two targets that we discussed earlier.
It’s up to you to choose the target to pursue.
However, it will be good for you to take target profits at each target level in order to book profits and reduce risks.
Of course, you will have your own trade management style that suits you, and this applies to other traders.
Let’s give an example of how you can manage a bullish Flag trade.
After opening your Flag trade, you put the stop loss below the extreme point of the Flag.
Once the price increases and completes the Flag size, you can close 1/3 of your position size and book the profits.
Also, you can adjust your stop loss order simply by raising it just below the initial target level.
If the price keeps on increasing and reaches your second target level, you can choose to close another 1/3 of the position so as to lock in your profits further.
Now, for the remaining trade, you can adjust the stop loss again so that it remains located just below the second target.
If the price keeps on trending upwards, you can monitor the price action carefully then hold the last 1/3 of the trade position for as long as you want.
Technical Analysis using Flag Patterns
You’re now becoming familiar with how to trade the Flag pattern.
I want to demonstrate how to perform technical analysis on this formation using a graphic.
Here is the graphic…
Above, we have a chart for U.S Dollar/ Singapore Dollar pair.
The chart clearly shows how you can perform a technical analysis to arrive at a potential trading opportunity.
The position of the Flag is shown using two black lines running parallel to each other.
The chart also shows that the best position for you to buy the currency pair is at the point where the Flag breaks out through the upper level of the Flag.
This has been marked as Buy and pointed to using a green arrow.
The breakout also confirmed the pattern and created a long opportunity on the chart.
The chart also shows the position where you should place your first stop loss order. This is simply the lowest point of the Flag. The position has been marked as Stop Loss 1.
If the price action tries to move below this point, you will automatically exit the trade.
This means you won’t make any further loss.
With every target, the stop loss order should be moved upwards. This helps you to lock in the profits as the price advances.
Locking in profits will save you from a situation where your profits are wiped out of your account when a price reversal occurs.
The other two stop loss orders have been marked as Stop Loss 2 and Stop Loss 3.
See that we have also measured the size of the Flag as well as that of the Flag Pole. The two sizes have been applied to the chart right from the breakout point. This is what we did previously.
Note that the two targets have been reached. After hitting each target, the stop loss should be adjusted accordingly.
The end of the trade occurs when the price of the currency pair breaks the third stop loss order.
That’s why the red arrow for Close points to that level.
After the Stop Loss 3, the price kept on declining.
Even future attempts by the price to rise did not reach this stop loss order.
Were it not for the Stop Loss 3, the trader would have incurred a severe loss in the long term.
Flags vs. Pennants
The Pennant formation is a continuation pattern that closely resembles a Flag.
The difference between these two is the shape of the correction that comes after the Flag Pole.
The Flag pattern forms a channel correction, while the Pennant forms a triangle correction.
However, the two patterns have the same potential.
Just like with Flags, there are two types of Pennants, the bullish Pennant and the bearish Pennant.
These two are traded in the same way as the Flag pattern and the target rules are similar.
If you see a bullish Flag, go long when the price breaks the upper level of the Flag.
If you see a bullish Pennant, go long when the price action breaks the upper level of the triangle correction.
Consider the following chart…
The above chart demonstrates how a Pennant chart is formed and how to perform technical analysis on it.
Notice that it is a bullish Pennant chart pattern.
The chart consists of a black triangle and a red bullish line, forming the pole of the Pennant.
The buy signal in the above chart points to the position where the price action forms a bullish breakout through the upper level of the Pennant.
This is what the green arrow on the chart shows.
The breakout also confirms the Pennant pattern, creating an opportunity for traders to enter the market.
That is the position at which you should join the trade by buying the currency pair.
At the same time, you should not forget to set a stop loss order just below the lowest point of the Pennant.
We have added this stop loss order and given it the name Stop Loss 1.
This will save you from incurring a loss should the price action move below this level.
You should also apply targets to the pattern. These have been shown using the vertical lines.
The first target should be equal to the vertical size of the black triangle, measured from the highest point.
The second target should be equal to the vertical size of the Pennant Pole.
Notice that the price managed to hit both targets, meaning that it was possible for the trader to adjust the stop loss order twice.
These stop loss orders are marked as Stop Loss 2 and Stop Loss 3.
Note that after hitting each target, the stop loss order should be adjusted.
The reason for doing this is to lock in profits. In case a sudden price reversal happens, the trader’s profits won’t be wiped out of the account.
The trader can hold the trade until the price actions reaches the Stop Loss 3 downwards.
If the price hits the Stop Loss 3, it will be closed automatically, preventing the trader from losing his profits.
From the above discussion, you can tell that the Pennant formation is the same as the Flag Pattern, and the same trading rules are applied to both.
Remember that what makes the two different is the nature of the correction.
-The Flag pattern is a weak pullback of a trend.
-The pattern is characterized by small-bodied candles, which are an indication that the pullback is weak.
-The Flag pattern gives two lines running parallel to each other.
-The best time to trade the Flag pattern is after a breakout. The breakout acts as a confirmation of the Flag pattern.
-You can also trade the Flag pattern when it is showing a strong trending market.
-Always place a stop loss order at the lowest point of the Flag pattern.
-A Flag pattern can be bearish or bullish.
-A bearish Flag begins with a bearish move, followed by channel correction in a bullish direction. It also has a bearish potential.
-A bullish Flag begins with a bullish move, followed by channel correction in a bearish direction. It also has a bullish potential.
-Flags and Pennants differ in the correction which comes after the Flag Pole.
-The Flag creates a Channel correction.
-The Pennant creates a triangle correction.