How to Trade a Bull Flag Pattern Successfully
When the market is good, and the stock is enjoying an upward trend, it produces a chart pattern referred to as a bull flag pattern. The name “flag pattern” comes from the fact that when you look at the chart, it resembles a flag hoisted on a pole. Since we are on an uptrend, it is thus considered a bullish flag.
The following features are usually common in a bullish flag:
- The pole is formed by the stock having made an incisive positive move on high relative volume
- The flag is formed by the consolidation of the stock on a lighter volume near the top
- The stock continues the positive trend by breaking out of the consolidation pattern. It is usually on a high relative volume
It is possible to use bull flags on any time frame. They are also part of our larger momentum trading strategy. As a method of scalping price movements in the short-term, we mostly use only two-time frames when trading bull flags; the 2 and 5-minute time frames.
They also work quite well on the daily charts, and they can also be used effectively for swing trading.
How to Trade the Bull Flag Pattern
Trading bull flags are quite simple. The challenge arises when looking for the right pattern. However, with scanners including Trade-Ideas, it is easy to look for stocks that are on an upward trend and then wait for them to consolidate their position up top.
Chart mill and Finviz are some of the best free scanners that you can use to find bull flags,
The following information might indicate a bull flag pattern:
- The stock is increasing at a high relative volume, mostly catalyzed by the news.
- Stock prices remain near highs or at highs with a clear pattern for pulling back.
- Make your move when the prices break out on high volume or above the consolidation pattern.
- Place your stop order just below the bottom of the consolidation pattern.
- The risk-reward ratio of 2:1 should be your profit target. So, if your initial risk is 25 cents, it follows that 50 cents should be your first PT.
The main thing that you should be looking out for in the pattern is volume. Volume is a good indicator of major moves and also that there will be a successful breakout.
A defined descending trend is a next thing you will want to watch out for. It will provide insights as to when the next point of breakout arises. That is the topmost part of the flag. In the above bull flag chart, the trend line is quite clear and defined as well. As such when it finally made its way through, the price shot up immediately. It is also clear how well the lines connect to the other upward moves that were turned down (3 points that include the top of the flagpole.)
Bull flags are very effective tools if they are traded in the right method. If something comes up, however, and the set up fails, you need to get to have an exit strategy. Put more emphatically, that is the point on the chart where you get to realize that it is no longer a viable trading route and it is time to move to other places.
There are two most used methods of managing this trade. Placing a stop order below the consolidation area is the most common among them. In the illustration given above, look at the line drawn just below the flag pattern. This is now the point where you agree to take the loss and move on to other prospects.
The second method is to use, as a stop, the 20-day moving average. You will need to close out your position if the price is the stock closes below the moving average.
Bull Flag vs. Bear Flag
The two flags are quite similar. The difference is the trend. It is a downside for the bear flag. There is usually a sharp down move on a highly relative volume. It is then followed by a slight pullback after which the trend continues. The most effective way of trading flags is by following the volume. Once there is a breakout, and the volume comes in, it is an indication that you need to now jump on board. This is an indication that there is about to be a dramatic success and that there were other traders that were waiting for the same thing.
Bull Flag vs. Flat Top Breakout
The major difference between trading a bull flag pattern and a flat top breakout is that the consolidation occurs below the high.
This means that if a flat top breakout is consolidating just by a few cents in the high, 2-3 red candles of the pullback will be experienced by a bull flag pattern. It can even go as far as to pull back to the 8 or 10 EMA and other fast-moving averages.
If in a bull flag we wait to buy the highs, we will be chasing, and even then, a proper stop (the bottom of the flag) may not be near. Therefore, I will buy the first candle, and at 2-3 red candles of pullback, I will make a new high.
I increase my risk-reward ratio by setting my stop quite close. That is at the low of the flag.
I can also double my position at the high moments of daybreak as well as well as sell through the spike. This will give me more money. It is also important to be careful so that you can avoid buying a double top.
A double top position will sometimes be seen at the top, or even a U shape. This happens when there is a huge pullback, and we squeeze our way back to the highs. In the illustrations provided below, you will get to have a look at some perfect bull flags as well as some sloppier ones.
It is also important to note that we trade only on the best and strongest stocks. As such, it is not just about the best pattern as it may not be as strong as one would like.
Bull Flag Pattern Components
For a continuation pattern to be considered as true, there must be a trend that was established before it, and it must be seen. It is always in the upward direction in the case of a bull flag pattern. Evidence of an advance or a sharp move will also be there. The basis of this is heavy trading in volume for the security. There may also be some small gaps.
In a basic bull flag pattern, this is usually the first of two advances. The second one arises after the flag pattern has emerged.
Heavy Volume of Trading
The next thing to lay your focus on during the positive trend is a heavy volume of trading. A heavy volume is a good indicator that a sharp and fairly quick move that leads to the formation of the flagpole is taking place. You might also need to look out for a consistent increase in price over the period of time that the bull pattern is on.
Once the resistance has been broken, and the price of the stock is once again moving upwards and also very quick, that is when the flagpole is formed. The furthest height of the flagpole will eventually be known as the topmost part of the flag itself in the pattern.
As we earlier stated, the flag itself us formed during the pause period. This is when the volume slows down and eventually the price of the security drops. The origin of the name of this pattern is quite basic. Once all the tops of the security line have been connected with a straight line and the same has been done for the bottom side, the line connecting the top and that connecting the bottom both appear to be parallel. They then go on to form what resembles a sloping rectangle altogether. The resulting figure looks like a flag. As if responding to the previous positive trends, bull flags always trend downwards. A tight flag pattern is an indicator that the securities have been performing stronger than the loose patterns. A tight pattern is where the price of any security does not move too far to one side or to the other during a pause period.
Professional opinions about a flag pattern usually vary depending on the actual valid duration. Though some use these opinions as a tool even with 12-week durations, most people prefer to use them only when they have lasted for one to eight weeks. The best bull flag patterns are usually in existence for only one to four weeks.
To identify the breaking point, take a close look at the trading volume of the securities. After a poor performance in the volume during the pause period, an increase in price, that appears to be sudden, is an indication that the stock is resuming its upward trend and that the resistance point has been broken.
Breakout Expectation Target
The price at the breakout point will be big, but by how much exactly? Most of the users of the bull flag pattern attach a line that originates from the lowest corner of the flag all the way upwards. This is an indication of how high the price is expected to go before the downward trend begins.
It is important to keep in mind that bull flag patterns aren’t always full proof. Like any pattern out there, they can be interpreted in many ways. They have, however, been shown to produce excellent results.
The Psychology of a Flag Pattern
As the bulls and bears become too ambitious, and the ‘other side’ is caught off guard, flag patterns get off to a violent start. The bears are usually blindsided due to their complacency. The bulls break out and charge ahead, leaving the bears to add to their shorts or panic. The bears get a chance to gain the much-needed confidence when the stock peaks out. They may add to their short positions, but they get trapped once more when the breakout happens. This causes more short-covering. Some short sellers from the initial flagpole upward run may still be trapped. The second breakout is even more severe for them regarding the price change and the angle. Forced liquidations and margin call usually kick in during this period. The same thing, but the inverse of it, happens on bear flags.
Planning a Trade Using Flag Patterns
Flat patterns will require you to be patient as you wait for the formation of the flag to plot the lower and upper trend lines. Your stop and entry levels will be contained. To time your entries, you can use a momentum indicator like stochastic. Crossovers for the 80/20 stochastic band will help to time you.
Two Trade Entry Spots
Flag formations all contain two spots of entry when one is in the game for the trend continuation break. The first is on the flag break and the second is when the high of the flagpole breaks.
The first entry is usually an early one. It allows the trader to take full advantage of an initial move that might take them back to the top most part of the flagpole and the before the stock breaks out or rejects. (graphics with entries and exit levels)
Two Trade Stop Loss Spots
If the stock is unable to hold the momentum, there are two stop loss levels that a flag pattern allows for. The initial one can be placed under the upper trend line and the lower trend line on the downtrends. This is just a precautionary trail stop. It may not be too wise to use the second trend line stop-loss since it is costly. However, it helps to stop premature stops by avoiding wiggles at the first trend line. You can use lighter shares when you want to offset some of the risks.
Once you have completely understood the working of the bull flag patterns, they are quite effective for beginner traders.
Similar to most patterns, breakout must be accompanied by volume. This serves to confirm the pattern and also increase the chances of success of the breakout.