A flag pattern is a strong, near vertical, move higher (or lower) followed by a consolidation. The price eventually breaks out of the flag (consolidation) and that move is also typically strong, as prior momentum continues. Flag patterns are considered a continuation pattern — the breakout is in the same direction as the prior strong move — although that isn't always the case. A breakout can occur in either direction. Aggressive traders attempt to anticipate the breakout direction based on other factors, such as trend and proximity to support/resistance. This is an advanced play; most traders wait for the breakout to actually occur, and then trade in that direction.
Here are four flag patterns, highlighting various ways to trade this chart pattern.
Wipro Ltd. (WIT) rallied from a low of $10.88 in January to a high of $14.18 in February, a 30% advance. Since the high the stock can been consolidating in a pennant formation (for trading purposes a flag and pennant are the same, just a slightly different look). The consolidation is confided by an upper and lower short-term trendline. A breakout above the upper trendline, currently at $14.05, signals another advance, while a drop below the lower trendline, at $13.63, signals a decline. (For more, see: Continuation Patterns: Rectangles and Pennants.)
WIT is trading right near the high from last February — a resistance area. Aggressive trades will be looking to go short near the upper trendline, with a stop loss above the $14.18 high. If the price breaks lower, they expect most of the prior rally to be erased, therefore targets would be placed at $13 and just above the January low, near $11.50. On the other hand, a strong break above the trendline pattern indicates a continued move higher, with a target of $14.80 to $15.00.
Fibria Celulose SA (FBR) is in a similar position. The stock rallied from a January low, and is now consolidating. A move above $13.25 breaks the consolidation and indicates more upside to come. To attain an approximate target take the height of the consolidation and add it to the breakout point of the consolidation. For a more aggressive target take the height of the prior rally, and add that distance to the bottom of the consolidation. These methods provide target of $13.86 and $14.74, respectively. (For more, see: Recent Flag Pattern Breakouts.)
This stock is also trading at resistance; in this case resistance is a trend channel. The price has shown a tendency to reverse at the top of the channel. Buying an upside breakout may not be the best play, since the breakout could fail so close to resistance. If a trader is bullish, it's better to buy near the consolidation low, or alternatively wait for the price to pullback to the long-term rising trendline before buying. This could also be considered a "common flag," discussed below.
comScore Inc. (SCOR) is not really a flag pattern, but could be traded in a similar way to a flag pattern. The stock had a strong gap higher in mid-February. In late February and early March the stock has been consolidating. Watch for a breakout of the consolidation. Given prior volatility, the next move could be volatile as well. Wait for the breakout on this one. Temporary resistance has formed between $52.50 and 52.64 — a breakout of that signals an advance, and a likely re-test of the $55.40 high. On the other hand, a drop below $51.50 also breaks the consolidation, and indicates more downside. Initial targets are the open of the gap higher, near $49.50, followed by $45, just above the launch point of the gap higher. (For more, see: What are the Most Common Continuation Patterns?)
The move higher was so big and aggressive that we would not use it to estimate an upside profit target if the price breaks the consolidation higher. The odds of another move like that occurring in the near futures is low.
Asbury Automotive Group Inc. (ABG) could be referred to as a common flag, or a flag of no particular importance. The stock rallied through January, but it had a pullback in the middle (not vertical). Looking at the last several months of price action, a rally of this type, followed by a consolidation, isn't uncommon. The price action following the breakout of prior consolidations isn't particularly compelling. These types of flags occur all the time. They aren't as crisp or as clearly defined (notice all the false breakouts on this and prior consolidations). When that occurs, it's best to leave them alone (if trading flags). (For more, see: Triangle Breakouts Could Lead to Decisive Moves.)
The Bottom Line
Flags come in all shapes and sizes. A flag should be a sharp swift price move of large magnitude, followed by a clearly defined consolidation. Watch for breakouts of the consolidation, in either direction. Use trends and or support/resistance if you want to get aggressive and anticipate which direction the breakout will be. A target can be based on the height of the flag added/subtracted from the breakout point, or the prior rally can be added (subtracted) to the bottom (top) of the consolidation for an upside (downside) breakout. The latter target method isn't useful when the rally was extremely large, since such a large move is unlikely to repeat. If going long, place a stop loss below the consolidation. If going short, place it above the consolidation. (For more, see: 4 Stocks Awaiting Strong Breakouts.)
Cory Mitchell doesn't have interests in any of the stocks mentioned.