Bullish Flag Formation Signaling a Move Higher

What Is a Bullish Flag?

Bullish flag formations are found in stocks with strong uptrends and are considered good continuation patterns. They are called bull flags because the pattern resembles a flag on a pole. The pole is the result of a vertical rise in a stock and the flag results from a period of consolidation. The flag can be a horizontal rectangle but is also often angled down away from the prevailing trend. Another variant is called a bullish pennant, in which the consolidation takes the form of a symmetrical triangle.

The shape of the flag is not as important as the underlying psychology behind the pattern. Basically, despite a strong vertical rally, the stock refuses to drop appreciably, as bulls snap up any shares they can get. The breakout from a flag often results in a powerful move higher, measuring the length of the prior flag pole. It is important to note that these patterns work the same in reverse and are known as bear flags and pennants. Bull flags typically begin to surface in conjunction with a new market rally.

Examples of Bullish Flags

Let's look at some examples of bullish flags appearing on price charts in order to illustrate the concept and how they appear visually.

Bullish Flag Emergence

The price chart from Answers Corp. below is a nice example of a bullish flag that may be breaking out. While the flag is not a perfect rectangle, what is more important is the basic premise behind the overall pattern. Note the strong rise in the stock as it forms the flag pole, and the tight consolidation that follows. Bulls are not waiting for better prices and are buying every chance they get.

The target for a bull flag is derived by measuring the length of the flag pole and projecting it from the breakout point. This would yield a target price in ANSW of around $9.50.

Rectangular Bull Flag

The price chart below for America Service Group Inc. is an example of a rectangular bull flag. Also, notice the long lower tails on the candles showing clear buying every time it dips under $10. Volume has also started to pick up over the past two sessions. A common characteristic of bull flags is the typical volume pattern.

Usually, there is a surge in volume as the stock builds the flag pole. Volume then tapers off precipitously as the stock price consolidates. The breakout from the bull flag often sees another increase in volume, although volume may not increase dramatically.

Bull Flag Breakout

Cantel Medical Corp.'s price chart is an example that appears to have broken out from a bull flag pattern. The top of the flag was clearly defined near the $15 area and CMN was able to close above that level. While CMN could enter another parabolic rise, often a stock will come back to test the breakout area a few sessions later, offering a second entry.

There are many options for protecting this type of trade with a stop loss. Longer-term traders often set their stops below the entire flag, and other traders employ tighter stops such as a two-bar stop.

Tight Bull Flag

CF International Inc.'s price chart is a great example of a really tight flag. Often, the tighter flags perform best, and they also offer easier stop-loss levels. Bull flags usually resolve one way or the other in less than three weeks. Over longer periods, the pattern becomes a rectangle or triangle.

As shown in the figure below, ICFI is moving above the resistance area near $24.50 after consolidating for more than a week. This follows the typical pattern and suggests that this stock could be on its way higher.

The Bottom Line

While no one knows whether the market rally will continue or reverse, traders should follow price action and let the probabilities take care of the rest. While all chart patterns are susceptible to false signals and surprise moves, bullish flags are among the most reliable and effective patterns.

Frequently Asked Questions

What is a flag pattern?

A flag is a price pattern used in technical analysis that, over shorter time frames, moves counter to the prevailing price trend observed across a longer period on a price chart. It is named because of the way it reminds one of a flag atop a flagpole.

What does a bull flag look like?

The bull flag has a sharp rise (the pole) followed by a rectangular price chart denoting price consolidation (the flag). Volume usually increases in the pole and then declines in the consolidation.

How reliable is a bull flag pattern?

Flag patterns are considered to be among the most reliable continuation patterns that traders use because they generate a setup for entering an existing trend that is ready to continue. Flag formations are all quite similar when they appear and tend to also show up in similar situations in an existing trend.

What happens after a bull flag?

If a bull flag is accurate, it will signal the continuation of an existing bull trend and the price will rise once the pattern completes.