Today I say Let’s trade flags. And no, I’m not saying you should swap flags with your friends. The flags I’m referring to are popular chart patterns called flags used in price action analysis. Sure, they are less popular than triangles wedges, and other price action patterns. but they’re just as reliable as the other patterns. So we’re gong to do as we always do. We’ll find out what these flag patterns are and how to trade them. So of we go.
First up is:
What are Flags?
A flag is a continuation pattern where a strong primary trend is followed by a period of consolidation before it resumes in the direction of the dominant trend. Shaped like a rectangle,the flag is formed by parallel lines that slope against breakouts emanating from support or resistance levels. Once the flag takes shape,an upward or downward trend,courtesy of the bulls and the bears,respectively suggests that the previous trend is about to resume.
When it comes to identification, the flag can be very difficult to spot. flags can form whenever a currency pair’s price consolidates. However,the most important factor to watch out for is a strong breakout above or below support and resistance levels. They may not completely eliminate the possibility of a reversal,but they do lower the odds.
Let’s take a look at illustrations of bullish and bearish flags.
As you can see,both the bullish and bearish patterns exhibit continuation patterns at the resistance and support levels. Notice the tall poles that form after breakouts at both resistance/support levels of the uptrend and downtrend. They help lower the possibility of a reversal.
Next we’re going to look at three Components of a Flag Pattern
The flag pole is the main facilitator as far as price action goes. It is represented quite well by both the uptrend and downtrend. The question bugging most people is “How do you calculate the flag pole’s price move?” Well, calculate the previous swing high or low from the current swing high or low. Let’s see an illustration below.
Keep watch over the tall flag pole you see to your left in the bullish pattern. Like I said in my description, the flag pole is the main initiator in the price movement. Wondering about measuring the price movement?Just calculate the last high/low to the current high/low.
At the risk of repeating myself, the flag is the real McCoy in this pattern. Like we said earlier, it starts with a strong trend followed by a period of consolidation where the main players take a breather before resuming hostilities regardless of whether it’s an uptrend or downtrend. Just to refresh your memory,let’s take a look at another illustration of the flag in action.
This is a classic flag move. You have a classic bullish move followed by a period of consolidation, as indicated by the two trend lines. After taking a huge breather, the bulls resume their journey. It goes without saying that long breathers,or long periods of consolidation can lead to aggressive breakouts. It’s like the calm before the storm.
Last but not least:
This is where the main actors have finished taking a breather and are resuming their journey. In other words, the market has finished consolidating and the main players are continuing to follow the trend- whether it’s an uptrend or downtrend.
This is what a continuation looks like. After a taking huge breather(my short for consolidation), the bulls march on upwards. The blue and red trend lines represent the period of consolidation. Nice looking trend if you ask me.
Now to the burning question of the day
How Do We Trade Flag Pattern?
Just like any other trade,look for a trading signal. You can find this trading signal in the breakout. If you are trading the bullish flag, make sure you make your buy trade when the candle closes above the upper side. If you are trading the bearish flag, place your sell entry on the lower side of the bearish flag pattern.
Of course, after you make your entry you put in a stop loss. You’d be crazy not to do that. Wouldn’t you?Anyways,for the bullish flag,place the stop loss below the lowest bottom in the flag. Conversely, for the bearish,flag,place your stop loss at the highest top.
Close out 1/3 of your position size and take the profits. This to protect your trade against any unexpected U-turn by the market.. Also to protect your position, raise your stop loss target just above the initial profit target. So that if the price reaches your second profit target, you will close another 1/3 of your trading position and lock in with further profits. No what do we do with the remaining trade? You readjust your stop loss just below the second profit target. If the price continues to soar, keep watch over the price action and hold the last 1/3 of your trading position for as long as you see fir.
Let’s take a look at the GBP/USD chart.
As you can see the green circle represents th moment the price broke through the upper part of the flag. BINGO! That will be the perfect time to make your entry trade. Once you execute the trade you put in your stop loss as shown in S/L1. Then with each target, you move the stop loss upwards, locking in profits,as price surges on. The magenta nd purple arrows show the size of the flag and size of the pole. And as each target is hit, the stop loss is adjusted to protect the trading position.
The end comes when the price breaks the third stop order(S/L3). As I’m sure you’ve noticed,the price reverses, creating unpleasant consequences for the long trade. Now I hope you’re sensible enough by then to get out while you can or else…….Kum ba yah.
That’s a wrap for “Let’s Trade Flags.” I hope you make significant profits with these flag patterns. Til next time take care.
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