A flag is defined in most major textbooks as a parallelogram that lines up with the current trend. In almost all cases, flags show the chartist a very short pause in the trading activity of the prevailing trend. Flags will last only a few weeks, while pennants though quite similar, will often represent as few as seven to 10 trading days. A pennant is often more symmetrical in design and somewhat horizontal in shape. History has shown us that the direction of the trend continues after the formation of the pennant has been completed. Both are examples of continuation patterns.

Tutorial: Analyzing Chart Patterns

If you were to sit down and study a number of charts today, you would be able to see quite a number of flags and pennants. The beauty of hindsight is that it is always 20/20. The key is to be able to spot the formation of the patterns as they are developing.

Imagine for purposes of this study, a dramatic day of trading that produces a long straight-line price bar that resembles a flagpole. In order for the market to catch up to this bold move, the next few days of trading will form a flag or a pennant, as the investors settle in to this new price range. If these next few days witness the stock trading in a narrow range with the highs and lows in a similar price pattern, then a Pennant is formed. If the highs and lows are falling off slightly in the opposite direction of the prevailing trend, then a flag is formed. A key to the recognition of both these patterns is that the volume will diminish dramatically.

continuation4NT_small.gif
Chart Created with Tradestation

You can see in this chart of Nortel Networks of Jan 2000 that a flag was formed over a six-day period followed by the continuation of the prevailing trend. The volume, although not shown in this example, diminished each day and did not pick up again until the next sharp upward movement of the stock on the seventh day from the initial development of the flagpole.

It is important to understand how we measure the flags and pennants. If we are to look closely at the "flagpole," the sharp increase or decrease in price action during one trading day, the next week or two will see the trading action fall off, creating lower lows and lower highs, until the next major move in the prevailing trend. It is understood that the trading action, as the flag is developed, will give back almost everything the flagpole acquired on that one day of the sharp increase or decrease.

With respect to flags and pennants in a downtrending market, the time it takes to develop will be dramatically shorter as investors tend to panic sell. One would merely have to chart the dotcoms during their crash to witness this statement.

continuation4GM_small.gif
(Chart Created with Tradestation) Click on chart for larger version

The Bottom Line
Both flags and pennants are preceded by a flagpole, one day of dramatic trading with heavy volume. They last a period of one to three weeks in time and the prevailing trend then continues. Because the setup time is so short, you will only be able to witness flags and pennants in daily charting.

Related Articles
  1. Chart Advisor

    3 Charts That Suggest Now Is The Time To Invest In Real Estate (VNQ, SPG,PSA)

    Real estate assets have some of the strongest uptrends around. We'll take a look at three candidates poised for a move higher.
  2. Chart Advisor

    Stocks With More Upside Due to Bear Traps (TAP, SPY)

    A bear trap is a pattern that typically leads to at least a short-term rise in prices. Here are stocks exhibiting the pattern.
  3. Active Trading Fundamentals

    New Traders: Trade the Market in 5 Steps

    New traders shouldn’t throw money at securities without knowing why prices move. Follow these five steps to tilt the odds in your favor.
  4. Chart Advisor

    Watch For a Bounce in These Emerging Markets (BRF, PEK)

    While downtrends are clearly in control of the direction of many emerging market ETFs, short-term indicators suggest a bounce higher could be in the cards.
  5. Investing Basics

    Valuation Models: Apple’s Stock Analysis With CAPM

    The capital asset pricing model, or the CAPM, estimates the expected return of an asset based on the systematic risk of the asset’s return.
  6. Stock Analysis

    Will "FANG" Stocks Outperform in 2016?

    Facebook held the most bullish accumulation-distribution pattern into year’s end, telling investors to focus on this issue in 2016.
  7. Chart Advisor

    Watch For Stock Breakouts Here

    Four stocks with potential breakouts across various time frames and pattern.
  8. Chart Advisor

    Stocks At Buy Points In Healthy Uptrends

    These stocks are in healthy long-term uptrends, and a recent pullback presents a buying opportunity.
  9. Chart Advisor

    The Uptrend Is Reversing In Financials

    Active traders are turning to financials because the close below several key long-term support levels suggest that the uptrend is about to reverse,
  10. Chart Advisor

    These 3 Charts Suggest Bears Control The Commodity Markets

    Many investors are wondering if they should be betting on a trend reversal in commodities. These charts suggest that a reversal might be further out than many hope.
RELATED FAQS
  1. How are pennant patterns interpret by analysts and traders?

    When developing an effective trade strategy, traders and analysts use a number of chart patterns and technical indicators ... Read Full Answer >>
  2. What is Fibonacci retracement, and where do the ratios that are used come from?

    Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician ... Read Full Answer >>
  3. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  4. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  5. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  6. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
Hot Definitions
  1. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  2. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  3. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  4. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
  5. Godfather Offer

    An irrefutable takeover offer made to a target company by an acquiring company. Typically, the acquisition price's premium ...
Trading Center