What is a flag pattern in forex?
A flag pattern is a continuation chart pattern, indicating a period of temporary consolidation before continuing in the direction of the original trend once the flag pattern comes to an end.
It is one of the best-known continuation formations in forex trading and considered to be significantly reliable by forex traders.
What separates the flag pattern from a typical breakout or breakdown is the formation of the flagpole, representing almost a vertical price move.
A flag pattern typically appears as a slight consolidation between impetuous legs of a price trend. When this pattern forms on a chart, there is a high probability that the price move will break out in the direction of the prevailing trend.
It is relatively easy recognizable once you know what to look for. Flag patterns are short-term patterns that typically extend 1 to 4 weeks.
The flag pattern derives its name from its two comprising components – a flag and a flagpole.
Simple illustration of a flag pattern
The flagpole
The flagpole represents a sharp strong price movement, forming virtually a vertical line. The price move must be prominently larger and quicker than the recent price moves before it. This swift and sudden price movement is an indication of strong buying or selling action.
The foregoing price trend is crucial for the formation of a flag pattern. However, every trending price move could transform into a flag. Therefore, every trend impulse could have the appearance of a flagpole.
The flag
A valid flag pattern starts to transpire when the shape of a flag begins to emerge after forming the flagpole.
The flag portion of the pattern is a consolidation period and resembles a parallelogram, comprising of price action with evenly distributed tops and bottoms. Put differently, after an uptrend, it has a downward slope and after a downtrend, it has an upward slope.
The duration of the flag portion is irrelevant, although, longer consolidation periods are inclined to more aggressive breakouts.
Ideally, the flag portion of the flag pattern must develop in the opposite direction of the preceding price move represented by the flagpole. A flag that is angled in the same direction as the preceding move, for instance, a flagpole and a flag both moving up, weakens the performance of the flag pattern.
Types of flag patterns in forex trading
There are two types of flag patterns, namely, a bearish flag, known as a Bear Flag, and a bullish flag referred to as a Bull Flag.
Bull flag pattern
The Bull Flag pattern forms during bullish trends in the forex market. It starts with an upside breakout (known as the flagpole), followed by a brief pause in the price trend, which is a minor bearish correction (referred to as the flag), followed by a stronger upward price movement.
The Bull Flag pattern is also called the Rising Flag pattern and is the exact inverse of the Bear Flag pattern.
Illustration of the Bull Flag pattern
Bear flag pattern
The Bear Flag pattern is the exact inverse of the Bull Flag pattern.
It is also known as the Falling Flag pattern and looks like a flag with the flagpole turned upside down.
The Bear Flag pattern forms during bearish trends, starting with a strong bearish price trend impulse (called the flagpole), followed by a rectification period of the downward trend by moving upwards. During the correction phase, a parallel channel is formed by evenly distributed tops and bottoms. This channel is referred to as the flag portion of the flag pattern.
After the flag period the price continues the prevailing bearish trend, moving downward.
Illustration of the Bear Flag pattern
Trading with flag patterns
A variety of trading strategies with regard to flag patterns can be found on the internet. The following information is only one of the many trading strategies to help forex traders in their trading endeavours.
Trading bull flag patterns
A bull flag pattern is formed by a price rally with an increase in volume.
There are several potential areas of entry for a long position when trading a bull flag pattern. Just to refresh, a long position is where a trader decides to buy a currency with the expectation that it will appreciate in value.
The first opportunity for a long entry is when the price breaks upwards out of the flag itself. A second potential point to buy is when the price produces a new high.
In order to reduce a possible loss on the long position, a stop loss order can be set below the start of the flag formation or one times the Average True Range (ATR) below the entry price.
It is often referred to that the flag is flying at half-mast, implying that the move following the breakout of the flag often equals the move before the flag. Thus, the trade target can be a move that equals the size of the flagpole.
Trading bear flag patterns
A bear flag pattern is formed after the selling of large volumes of a currency in a short period of time.
Trading a bear flag pattern is similar to the trading of a bull flag pattern.
However, in this case a short position is executed, meaning that the trader intends to sell the currency in the hope that its price will fall in the future, enabling the trader to buy the same currency back at a later stage but at a lower price.
A potential entry for a short is when prices break down to a fresh low, a breakout of the flag, or a retest of the breakout point after the flag was formed.
Trading flag pattern – in summary
As mentioned, flag patterns are created by a sharp price move of a currency (the flagpole), followed by a consolidation which occurs between two parallel lines, or almost two parallel lines. Look to trade opportunities presented by breakouts of the consolidation. A breakout can be in the opposite direction of the sharp move, or in the same direction.
However, keep in mind that the main problem with trading flag patterns is a false breakout.
Where necessary, make use of a stop loss.
Only trade the flag patterns during the volatile times of the trading day.
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