Bullish flag formations are found in stocks with strong uptrends. 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 have been rare over the last few months of 2008, but they have been beginning to surface in conjunction with the recent market rally.
Answers Corp. (Nasdaq:ANSW) is a nice example of a bull flag that may be breaking out. While the flag isn't a perfect rectangle, what's more important is the basic premise behind the overall pattern. Note the strong rise in the stock in mid December 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.
America Service Group Inc. (Nasdaq:ASGR) 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 for bull flags is the typical volume pattern. Usually, there is a surge in volume as the stock builds the flag pole. Volume then drops off precipitously as the stock consolidates. The breakout from the bull flag often sees another increase in volume, although volume may not increase dramatically.
Cantel Medical Corp. (NYSE:CMN) is a stock 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.
CF International Inc. (Nasdaq:ICFI) 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 10 days. This follows the typical pattern and suggests that this stock could be on its way higher.
While no one knows whether the market rally will continue or reverse in early 2009, traders should follow price action and let the probabilities take care of the rest. While all chart patterns are susceptible to false moves, bull flags are among the most reliable and effective patterns.
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