Flag Pattern: Although there might be different schools of thought out there with regard to forex trading, unless you want to go down the route of AI trading and using algorithmic trading, then you have no other alternative than to actually learn how to analyze the market.
Of course you can depend on various methods to analyze the market, including fundamental analysis. But the crux of the matter in the final analysis will come down to technical analysis.
If you have any experience with technical trading, you know that many of the indicators and patterns are very simply named after the shape and pattern that they resemble. The same is true with the flag pattern. So you can have a rough idea of how it looks. But what exactly is it? What does it tell us? And how can we trade with flag patterns? Find out the answer to all these questions in this article.
What Is the Flag Pattern?
In simple terms, the flag pattern is a short term trend that moves in opposition with the general and prevailing trend in the market. It creates sort of a pause in the overall trend in the market before things keep going in the same trajectory again.
Therefore, a flag pattern is a short term trend reversal placed in the overall long term trend of the market.
Mainly, the flag chart pattern is used to identify a trend in the market that says the previous trend will keep going instead of reversing. Therefore, traders can use this pattern to see whether the bearish trend or the bullish trend will keep going in the long term.
Therefore, there are two main types of bearish and bullish flag chart patterns. Of course they are named as such because of the detected trend in the market previous to the formation of the flag pattern.
Flag Patterns: How Are They Formed?
Flag patterns are by nature short term patterns. While some patterns might be longer term lasting for even days or months, the flag chart pattern is generally a shorter one. Because it is technically considered a counter trend. Going against the prevailing trend in the market for a short time before the aforementioned trend continues as before.
An important characteristic of the flag pattern is the distance between the highs and lows registered in the pattern. Remember, it should form the general outlook of a flag. So the ending of the pattern should not be too narrow. In fact, it should be generally as thick as the middle part of the flag. Naturally, if it is otherwise, the pattern would turn into a triangle and not a flag.
Other than the main part of the pattern which is the flag itself, there needs to be a trend before the formation of the pattern. At times, we can observe a trend in the market that is called a sideways trend. In this situation there is no prevailing pattern toward up or down. But for the flag chart pattern, the existence of a trend is crucial prior to the formation of this indicator.
How to Detect the Flag Pattern?
Aside from the telltale signs that we mentioned earlier, including the existence of a trend prior to the format of the pattern and the general outlook of the pattern itself with regard to the thickness of its various parts, another important factor is of course trading volume.
Trading volume is almost always taken as a crucially significant factor in order to confirm the formation of the pattern such that traders can reliably use it to enter into a position.
As far as flag patterns are concerned the change in the trading volume depends on the type of the flag pattern – i.e. whether bearish or bullish.
In case of the bearish flag pattern the trading volume would decrease at first but then pick up and get higher as the flag nears its consolation. But it is the opposite with a bullish pattern. With a bullish flag pattern, trading volume tends to be higher at first but would decline a bit when the flag gets close to its consolidation point.
How Can Flag Patterns Be Used for Trading?
The way you should use the flag pattern for trading is similar to any other technical indicator with regard to the actual steps involved. First of all you need to pick the correct entry point. Then you need to specify the goal toward which to strive – this would be your profit targets. Of course, just as importantly, you need an exit strategy. This would constitute a stop loss. So, let’s go through them one by one.
First the entry point.
There are many technical indicators that are known as continuation patterns. So as the name suggests, they indicate that the previous trend in the market will “continue” in the same direction. Flag patterns are also regarded in this category.
However, just because they are continuation patterns, it does not mean you should trust them as they are and place your bests in the market as soon as they are formed. Quite the contrary. You should wait for the consolidation to take place and wait to actually see the price breakout first. The reason is that there is always the possibility of a false signal in the market.
False signals are actually the most dangerous pitfalls in the case of technical analysis. Do not trust a pattern on its own. You should always look for ways to confirm the pattern.
So for the flag chart pattern, perhaps the best entry point would be just before or just after the consolidation of the trend lines.
As far as the stop loss is concerned. It is actually not too difficult with the flag pattern. You only need to place your stop loss at the exact opposite side of the flag. And for your profit targets, you can calculate the difference that is between the parallel trend lines of the pattern.
Flag pattern is a technical indicator that is classified to be a continuation pattern which means when it occurs you can expect the same trend in the market to continue down the same route. There are however many similarities between flags, triangles, wedges, and pennants. So you should be careful about distinguishing between them using different telltale signs of each indicator.