Hello dear friends, if you're interested in technical
analysis, you must have heard of the chart patterns frequently used in Forex
trading. Trends in financial markets constantly change. To predict these
changes in advance and find the direction of the trend, we can refer to easily
understandable chart patterns. In today's article, we will focus on the Flag Pattern. I hope this article will be a useful resource for both beginner and
intermediate traders.
What is the Flag Pattern?
The Flag pattern is known in technical analysis as a
continuation pattern. Regardless of the trend it occurs in, whether in an
uptrend or downtrend, the Flag pattern indicates a short-term correction in
prices. During this period, prices fluctuate within a defined area bounded by
parallel lines. Then, a breakout occurs either upward or downward from this area,
and the current trend continues. Therefore, there are two types of Flag
patterns:
- Bullish (Rising) Flag pattern
- Bearish (Falling) Flag pattern
The Bullish Flag pattern is usually seen in an uptrend. When
prices break above the parallel zone, the continuation of the uptrend is
expected. The Bearish Flag pattern, on the other hand, usually appears in a
downtrend. When prices break below the parallel zone, it becomes clearer that
the downtrend will continue. Both Flag patterns are generally considered to be
signals that the trend will continue.
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| The Flag Chart Patterns |
How does the Flag Pattern Form?
One of the most sought-after patterns in financial markets
is the Flag pattern. This chart pattern can form in both bullish and bearish
trends. Both main Flag patterns vary depending on the direction of the trend in
the market. Rising flags usually indicate a continuation of an uptrend, while
falling flags signal a continuation of a downtrend. Flag patterns are visually
more noticeable on the price chart when they form and have the following basic
components in their structure:
Flagpole: The pole represents a relatively steep (less
volatile) price movement that occurs at the beginning of the Flag pattern. The
formation of the Rising Flag pole starts with a steep upward movement, while
the Falling Flag pole forms with a steep downward movement.
Flag: After the Flag pole, a horizontal price movement is
observed, forming the flag part of the pattern. During this process, prices
fluctuate between parallel lines, creating a correction. In the Rising Flag,
this correction occurs with a slight downward movement, while in the Falling
Flag, it is manifested by a slight upward movement.
Once the flag pattern completes, it often signals a
continuation of the trend, and prices resume their movement in the direction of
the current trend. A Flag pattern in an uptrend usually signals a continuation
to the upside, while a Flag pattern in a downtrend usually signals a
continuation to the downside.
How to Trade with the Flag Pattern?
By using the Flag pattern in combination with other
technical analysis tools, we can confirm trends and generate trading signals.
Also, the longer the flag formation, the more reliable it is considered.
Besides that, by observing the direction of the breakout in the Flag pattern,
we can place buy or sell orders. Each pattern has its own unique outcomes based
on the direction of the breakout.
Trading with the Bullish Flag pattern
The Bullish (Rising) Flag pattern occurs in a bullish trend.
During this process, prices fluctuate between parallel lines for a period,
creating a correction. The upper line (top line) typically acts as a
resistance, and therefore, we expect a breakout of this line. This breakout
indicates that the uptrend is gaining momentum and presents buying
opportunities.
Entry (Buy): A buy order can also be placed when prices
break above the upper line (top resistance) of the flag. Alternatively, after
this breakout, prices may pull back to test the broken line, and a buy order
can be placed as they start to rise again.
Stop Loss: The stop loss level is set at a level slightly
below the bottom line of the flag or slightly below the break point.
Target: The target is determined by adding the height of the
parallel lines for short-term trading and the height of the flagpole for
long-term trading to the breakout point.
A trade example with the Bullish (Rising) Flag pattern is
shown in the chart of the Australian Dollar/New Zealand Dollar (AUD/NZD)
currency pair below. As can be clearly seen from the chart, when the Bullish
Flag pattern forms, the price continues its upward trend. The "h" in
the chart represents the flag height, i.e., the distance between the parallel
lines, while "H" indicates the length of the flagpole. Based on these
measurements, target 1 and target 2 levels have been identified for long
positions:
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| Bullish Flag Pattern on the AUD/NZD chart |
Trading with the Bearish Flag pattern
In a bearish trend, the Bearish (Falling) Flag pattern is
observed. In this pattern, prices fluctuate between parallel lines for a
period, showing a correction movement. The bottom line usually acts as a
support level. In this case, we expect prices to break below the bottom line.
This breakdown emphasizes a deepening of the
downtrend and indicates that selling is appropriate.
Entry (Sell): Selling can be executed when prices break
below the bottom line (bottom support). Also, if prices pull back to test the
breakdown point and then fall again, a sell order can be placed.
Stop Loss: The stop loss level can be set slightly above the
breakdown point, just above the top line of the flag, or at another suitable
level.
Target: The target price is determined by adding the height
of the parallel lines for short-term trading and the height of the flagpole for
long-term trading to the breakdown point downward.
In the chart below, an example of trading with the Bearish (Falling)
Flag pattern in the Canadian Dollar/Swiss Franc (CAD/CHF) currency pair is
presented. As seen in the chart, the price continues to decline after the
formation of the Bearish Flag pattern. In this chart, the letter "h"
represents the height of the flag body, i.e., the distance between the parallel
lines, while the letter "H" represents the length of the flagpole.
Based on these measurements, target 1 and target 2 have been determined for short
positions:
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| Bearish Flag Pattern on the CAD/CHF chart |
Pay Special Attention to this Matter: As always, trading based on a single pattern alone can lead to undesirable outcomes. The Flag pattern, too, can occasionally provide false signals. Therefore, confirmation should be done with other technical analysis tools and aligned with fundamental analysis while trading. Additionally, risk management should be the core element of our trading.