What is a Flag
A flag is a technical charting pattern that looks like a flag on a flagpole and suggests a continuation of the current trend. Flags are areas of tight consolidation after a sharp movement in price and typically consist of between five and 20 price bars. The bottom of the flag should not be lower than the midpoint of the flagpole that preceded it. Likewise, "pennant" formations are usually treated like flag formations because they are very similar in appearance, tend to show up at the same place in an existing trend, and have the same volume and measuring criteria.
BREAKING DOWN Flag
Flags and pennants are among the most reliable continuation patterns that traders use. The only difference between the two patterns is that a flag resembles a parallelogram (or rectangle) marked by two parallel trend lines that tend to slope against the prevailing trend. The pennant, however, is identified by two converging trendlines and more horizontal which resembles a small symmetrical triangle. The important thing to remember is that they are both characterized by diminishing trade volume, and though different, the measuring implications are the same for both patterns as demonstrated in the above illustration. (To learn more, see: What are the Fundamental Differences between a Pennant Pattern and a Flag Pattern?)
How to Trade a Flag Pattern
- Entry: Even though flags suggest a continuation of the current trend, it is prudent to wait for the initial breakout to avoid a false signal. Traders could enter a flag on a break above (long position) the upper parallel trend line.
- Stop Loss: Traders could use the opposite side the flag pattern as a stop loss point. For example, if the lower trend line of the pattern is at $10, a logical place to set a stop-loss order for a long position would be at $9.90, just below the round number.
- Profit Target: Conservative traders may want to use the difference, measured in price, between the flag pattern’s parallel trend lines to set a profit target. For instance, if there is a $5.00 difference and the breakout entry point is $40, the trader would place a profit target at $45. A more aggressive approach would be to measure the distance in dollar terms between the pattern’s high and the base of the flagpole to set a profit target. For example, if the distance is $25, the profit target would be placed above (long position) the breakout point by that amount. Another option would be to set a profit target for half of the position using the flag’s width and use the distance between the high and low of the flagpole to take profit on the remaining half.