Last Updated on 10 February, 2024 by Trading System

What Does A Flag Mean in Trading? Traders have different approaches to trading. While some make use of fundamental analysis, others make use of technical analysis. Among those who make use of technical analysis, many prefer to analyze the charts for reliable price action patterns, and one of those patterns is the flag. But what does a flag mean in trading?

In price chart analysis, a flag is a continuation chart pattern that forms when the market consolidates in a narrow range after a sharp move. The pattern can be seen in any timeframe, and it consists of a small rectangular price formation that follows a fast price movement. It is named a flag pattern because of its similarity to a flag on a flagpole.

To help you fully grasp the flag pattern, we will discuss it under the following headings:

• What does flag pattern mean?
• How do you identify a flag pattern?
• Examples of the flag pattern: the different types
• How do you trade a flag?
• What is a 1234 pattern?
• What is a high tight flag pattern?

What does flag pattern mean?

A flag, in technical analysis of the financial markets, is a continuation chart pattern that forms when the market consolidates in a narrow range after a sharp move. The pattern can be seen in any timeframe, and it consists of a small rectangular price formation that follows a fast price movement. A relatively short chart formation, the flag appears as a small channel that develops in the opposite direction after a steep trend.

The pattern is named a flag pattern because of its similarity to a flag on a flagpole. It is a price chart characterized by a sharp countertrend price consolidation (the flag) that follows a short-lived trend (the flag pole). The flag could be horizontal, but most commonly, it slants against the preceding price move.

The flag pattern represents the market taking a breather before resuming its movement, so it is one of the popular continuation patterns. Although it is less popular than triangles and wedges, traders consider flags to be extremely reliable chart patterns; hence, they use it to identify the possible continuation of a previous trend from a point at which price has drifted against that same trend.

For this purpose, the flag pattern has to be accompanied by corresponding volume changes because even though it is mostly followed by a breakout in the trend direction after the period of consolidation, the price can also reverse, especially if the volume data doesn’t support the continuation move. Often, when the trend resumes, the price movement tends to be rapid, just like the one that precedes the flag formation. So, it is important to notice the flag pattern in time and position to take advantage of it.

How do you identify a flag pattern?

A flag is an area of tight consolidation in price action — which may show a counter-trend move — that follows directly after a rapid directional movement in price. The flag pattern can form in both an upward trend and a downward trend. To identify a flag pattern, here are the three main characteristics:

• The flagpole: This is a swift price swing in the direction of the preceding trend.
• The flag formation: This is a consolidation channel that forms the flag pattern. The pattern typically consists of between five and fifteen price bars that fall within a small channel.
• A breakout/breakdown: This is the price closing above the upper channel boundary in the case of a flag formation in an uptrend or below the lower boundary of the channel in the case of a flag formation in a downtrend. This breakout/breakdown confirms that the price is about to continue moving in the direction of the trend.

There are other characteristics of the pattern that you should know. One of them is that the bottom of the flag should not exceed the midpoint of the flagpole that preceded it. Another one is that the price consolidation is often within a channel — parallel lines along the highs and lows of the price bars or mini swings. If the lines converge, the consolidation looks like a small wedge, and the formation is referred to as a pennant pattern.

Both flag and pennant patterns are among the most reliable continuation patterns used by price action traders because the patterns create a visible setup for entering an existing trend that is ready to continue. Since these formations are all similar, they tend to form in similar situations in an existing trend.

Examples of the flag pattern: the different types

As we stated earlier, the flag pattern can form in either an up-trending or a down-trending market, but whatever the preceding trend, the pattern signifies a potential trend continuation. Hence, in an uptrend, it signals a potential bullish move, while in a downtrend, it signals a potential bearish move.

So, depending on the direction of the preceding trend, a flag pattern can be of two types:

• A bullish flag (Bull flag)
• A bearish flag (Bear flag)

What does a bullish flag mean?

A bullish flag (Bull flag) is a flag pattern that forms in an up-trending market. It consists of a rapid upward price swing (the flagpole) that is followed by a price consolidation that forms within a small down-slanting channel (the flag). The flag formation often consists of both bullish and bearish price bars, but they mostly lie within a downward price channel that serves as a pullback. The lowest point of this consolidation is often above the midpoint of the preceding upswing (flagpole).

The pattern completes when the price breaks above the upper boundary of the channel to start another upward price swing, signaling the continuation of the uptrend. Thus, a bullish flag is a bullish continuation chart pattern, and traders use it to know when to place a buy order in an uptrend or add to their already-existing long positions.

What happens after a bullish flag?

After a bullish flag forms on the price chart, the price is likely to resume the uptrend that is already in place. However, this is not always the case, as the price can breakdown below the lower boundary of the price channel and make a deeper pullback or even a complete reversal.

The price is more likely to resume the upward movement if it breaks above the upper channel of the flag pattern with a high volume surge to show that traders are going long. On the flip side, if the flag formation descends below the halfway mark of the preceding upswing, or the price breaks below the lower boundary of the channel with a high volume surge, there may not be a bullish continuation move.

How do you spot a bear flag?

A bearish flag (Bear flag) is a flag pattern that forms in a down-trending market. It consists of the following:

• A rapid downward price swing (the flagpole) that is followed by
• A price consolidation that forms within a small up-slanting channel (the flag). The flag formation often consists of both bullish and bearish price bars, but they mostly lie within an upward price channel that serves as a pullback. However, the highest point of this consolidation should be below the midpoint of the preceding downswing (flagpole).
• A breakdown below the lower boundary of the channel, which starts another downward price swing and signals the continuation of the downtrend.

What happens after a bear flag?

Normally, a bearish flag is seen as a bearish continuation chart pattern, and traders use it to know when to enter a short position in a downtrend or add to their already-existing short positions. Thus, after a bearish flag forms, the price is expected to resume the downtrend that is already in place. But this is not always the case, as the price can break out of the upper boundary of the price channel and make a deeper pullback or even a complete upward reversal.

One way to know if the price is more likely to resume the downward movement is if it breaks below the lower channel of the flag pattern with a high volume surge to show that traders are trading in that direction. On the flip side, if the flag formation rises above the halfway mark of the preceding downswing, or the price breaks above the upper boundary of the channel with a high volume surge, there may not be a bearish continuation move.

How do you trade a flag? (Bull flag or Bear flag)

As one of the reliable chart patterns, the flag pattern is a key part of many price action traders’ trading arsenals. If you learn how to trade with the flag pattern, you can use it to establish your trade entry, stop loss level, and profit target. Let’s see how you can trade the two types of the flag pattern:

How do you trade a bullish flag?

A bullish flag pattern can show you when to buy, where to place your stop loss, and where to take profit:

• When to buy: Although the bullish flag implies a potential continuation of the current uptrend, to avoid a false signal, it is wise to wait for the price to break above the upper boundary of consolidation. A breakout is valid only after the price has closed above that upper boundary, so if you are trading on the daily timeframe, you may go long at the open of the next trading day.
• Your stop Loss level: Usually, the lower boundary of the flag formation is used as a reference point for the stop loss order. You can place your stop loss somewhere below that lower boundary of the channel when the breakout happened. For instance, if the upper boundary of the channel is at $63 per share and the lower boundary is at $60 per share when the breakout happened, then you can place your stop loss order some cents or a dollar below the $60 level.
• Your profit target: Normally, when the price breaks out, it is expected to make a similar upswing to the one that preceded the flag pattern consolidation. So, you can measure the size of the flagpole and use it to estimate your profit target from the lower end of the breakout point. However, if you want to take a quick profit or make use of two profit targets, a more conservative profit target would be to use the size of the consolidation channel (the flag). For example, if the distance between the upper boundary and lower boundary of the flag is $3, you measure $3 from the upper boundary, and that becomes your conservative profit target.

How do you trade a bearish flag?

A bear flag tells you the following:

• When to sell: The right time to place a sell order is when the price breaks below the lower boundary of flag formation. A breakdown is valid only after the price bar has closed below the lower boundary. Thus, if you are trading on the daily timeframe, you should go short at the open of the next trading day.
• Your stop Loss level: The lower boundary of the flag formation is used as a reference point for the stop loss order, so you can place your stop loss somewhere above that upper boundary of the channel when the breakout happened. For example, if the upper boundary of the channel is at $52 and the lower boundary is at $49, you can place your stop loss somewhere above the $50 level.
• Your profit target: The usual thing is to measure the size of the flagpole and use it to estimate your profit target from the upper end of the breakout point. However, if you want a more conservative profit target, you may use the size of the consolidation channel (the flag). For example, if the distance between the upper boundary and lower boundary of the flag is $3, you measure $3 from the lower boundary, and that becomes your conservative profit target.

What is a 1234 pattern?

This is a price action pattern described by a renowned price action trader, Jeff Cooper, in his book: “Hit & Run Trading: The Short-Term Stock Traders Bible.” The 1-2-3-4 chart pattern consists of at least 3 consecutive price bars with lower lows and lower highs. The pattern is completed when the price closes above the high of the last price bar in the pattern. This pattern is best traded on the daily timeframe.

What is a high tight flag pattern?

The high tight flag is a form of the Bull flag pattern. It is one of the most bullish chart patterns and occurs in a strong trend. The consolidation price range pattern that forms after the strong uptrend can look like a flag or a pennant or just a pause, but it forms the base for the next price upswing.

FAQ

How do you identify a flag pattern?

A flag pattern is identified by three main characteristics: a swift price swing in the direction of the preceding trend (flagpole), a consolidation channel forming the flag pattern, and a breakout/breakdown where the price closes above the upper boundary (bullish) or below the lower boundary (bearish) of the flag.

What does a bullish flag mean?

A bullish flag is a continuation pattern in an up-trending market. It consists of a rapid upward price swing (flagpole) followed by a consolidation in a downward channel (flag). The pattern completes when the price breaks above the upper boundary, signaling a continuation of the uptrend.

How do you spot a bear flag?

A bearish flag is a continuation pattern in a downtrending market. It involves a rapid downward price swing (flagpole) followed by a consolidation in an upward channel (flag). A breakdown below the lower boundary signals the continuation of the downtrend.