Flag Patterns And How To Trade Them

Prices do not simply move up and down on a chart. Even when the security is in a trend, price will move with the trend, pause and correct, and then continue in the trend direction. Often there will be a pattern observed on the chart when price is in the pausing mode. Understanding and recognizing these patterns can offer traders higher probability trading opportunities.

One of the most common and popular patterns is the flag. The flag formation can either be bullish or bearish depending on the trend and shape.  Let’s examine the flag patterns and learn how they can help improve trade decisions.

What Is a Flag Pattern?

The flag pattern is called a flag because the price action on a chart resembles a flag sitting on a pole. The pole is created by a sharp rise or fall in price and is then followed by a sideways trend that ends with another sharp rise or fall in price.

Bull Flag Patterns

A bull flag pattern is formed by a rally in price with an increase in volume. The high volume during the rally exhausts the buying pressure that was propelling price higher, which forms the pole. Price then consolidates, forming the flag, and then moves either sideways or against the trend as investors wait for more buying pressure to build up.

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Stock chart illustrating what flag patterns look like.

How to Trade a Bull Flag Pattern

When trading bull flag patterns, there are several potential entry areas for a long position. The first long entry can be taken once prices break upwards out of the flag itself. A second potential entry point is when price makes a new high. Lastly, traders can wait for prices to retest the breakout point by changing their chart to a lower time frame.

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Stock chart showing the high and breakout of a flag pattern

A stop loss can be set below the beginning of the flag formation or one times the Average True Range below the entry price.

The flag is often said to be flying at half-mast. This means that the move following the breakout of the flag is often equal in size to the move before the flag itself. So, the target for the trade can be a move equal to the size of the flagpole.

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