In technical analysis, flag patterns show short-term price movements in a parallelogram counter to the previous long-term trend. Traditional analysts see flags as indicators of potential trend continuation.
There are two types of flag patterns: bull flags and bear flags. While the results vary, each flag exhibits five main characteristics, as shown below:
- A strong previous trend (flagpole or pole)
- Consolidation channel (own flag)
- Trading volume patterns
- A breakout
- A confirmation of the price moving in the direction of the previous trend.
In this article, we discuss bull and bear patterns and how to trade them.
What is the bull flag pattern?
A bull flag is a technical pattern that appears when price joins below a downward sloping channel after a strong uptrend. The channel consists of two parallel trend lines. It is important to note that the pattern can become a wedge or a flag if the trend lines converge.
Volume usually dries up during consolidation, which indicates that traders associated with previous trends are less quick to buy or sell during periods of consolidation.
The need to jump by new and old investors, or “FOMO” (fear of missing out), usually returns when the price falls above the trend line of the bull flag, thus increasing trading volume.
As a result, analysts see strong volume as a sign of a successful bull flag breakout.
On the other hand, lackluster volume when the price breaks above the trendline above the bull flag increases the possibility of a fakeout. In other words, the risk of the price falling below the upper trend line, thus canceling the bullish continuation setup.
Trade the bull flag setup
Traders can enter a long position below the bull flag in anticipation that the next price move to the upper trend line of the pattern will trigger a breakout. Cleaner traders can wait for breakout confirmation before opening a long position.
For bullish targets, the breakout of a bull flag usually causes the price to rise to the size of the flagpole when measured from the bottom of the flag.
The following Bitcoin (BTC) price pattern between December 2020 and February 2021 shows a successful bull flag breakout setup.
As a note of caution, traders should protect their risk by placing their stop loss below the entry level. This will allow them to reduce their losses if the bull flag is invalid.
What is the bear flag pattern?
The bear flag pattern is the opposite of the bull flag pattern, which shows an initial downward move followed by an upward consolidation in a parallel channel. The downward movement is called the flagpole, and the upward consolidation channel is the bear flag itself.
Meanwhile, bear flag formation periods tend to coincide with declining trading volumes.
Trade the bear flag pattern
Below is an illustration of how to trade a bear flag pattern on a crypto chart.
In the Bitcoin chart above, the price has formed a flagpole followed by an upward retracement inside the upward parallel channel. Finally, the price of BTC broke out of the channel range to the bottom and fell to the height of the flagpole.
Traders can choose to open a short position by pulling back from the flag’s upper trend line or wait until the price drops below the lower trend line with increasing volume.
In any case, the short target, as a rule, is measured by subtracting the top of the flag from the size of the flagpole.
Related: What is a Doji candlestick pattern and how do you trade it?
Meanwhile, a breakdown below the flag’s lower trend line accompanied by weak volume indicates a fakeout, meaning that the price may retrace the lower trend line as support for a potential rebound in the parallel channel.
To limit losses in fakeout scenarios, it is important to place the stop loss just above the entry level.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should do their own research when making decisions.