Flag Tutorial

Start with the Introduction and work your way through to mastering all the basics you need for trading Flags.

  Introduction to Flag Trading
  • Introduction to Flag-Trader
  • Flag Patterns
  • Trending Stocks
  • Finding Flags and Trending Stocks
 

Flag Patterns

My favourite chart pattern is a flag pattern. This occurs after a thrusting surge (the flagpole) then consolidates (to form the actual flag). The thrust can occur in either an upwards (bullish) or downwards (bearish) direction.

A Flag occurs during a persistent and dominant trend and temporarily interrupts that trend before resuming it.

The flag itself consists of the price pattern rebounding off 2 parallel interim trendlines before breaking out in the direction of the dominant trend.

Bull Flag:

With bull flags, our entry is a buy order and our stop loss is a sell order. We anticipate a rising stock price.

So here we can see that we have the makings of a trading plan:

We enter our buy order at either point A or B.

Point A is at the level of the top of the flag. As such it is the most conservative entry point, because it is where the stock is making new highs. You must make sure that volume is increasing as the new high is made. Increasing volume means there is conviction behind the move, which makes it more likely to be sustainable.

Point B is where the stock breaks out of the flag itself. This is more aggressive than Point A, and again requires increasing trading volume to demonstrate conviction in the move.

If the entry is activated then we need a stop loss. Point C is the level where, if we're already in the trade, we'd exit with a small loss.

This is your basic trading plan for a Bull Flag, within the context of an upward trend.

Bear Flag:

With bear flags, our entry is a sell (short) order and our stop loss is a buy order to close the position. We anticipate a falling stock price.

We enter our sell (short) order at either point A or B.

Point A is at the level of the bottom of the flag. As such it is the most conservative entry point, because it is where the stock is making new lows. You must make sure that volume is increasing as the new low is made. Increasing volume means there is conviction behind the move, which makes it more likely to be sustainable.

Point B is where the stock breaks out of the flag itself. This is more aggressive than Point A, and again requires increasing trading volume to demonstrate conviction in the move.

If the entry is activated then we need a stop loss. Point C is the level where, if we're already in the trade, we'd exit with a small loss.

This is your basic trading plan for a Bear Flag, within the context of a downward trend.

Let's look at an example of each:

Chart 7: Trendlines

Chart 8: Bear Flag

Flags within the context of a Trend

Now, what if I then said to you, how about finding flags within the context of a trend? That means you can play the flag, knowing that the trend is backing you up. Now we're beginning to add some backbone to our trading plan!

All we have to do is draw a trendline to see if the flag is forming within the context of a trend.

In the above two examples we can see that this is the case. The Bull Flag is within the context of a 2-month up trend and the Bear Flag is within the context of a 1-month down trend.

Chart 9: Bull Flag resolved to the upside

Chart 10: Bear Flag resolved to the downside

If the trendlines are broken then we would exit the long (Bull Flag) or short (Bear Flag) positions. Similarly, to enter into the long position, the price would need to rise above the top of the Bull Flag or break up through the upper flag trendline.

To enter the short position the price would need to fall below the bottom of the Bear Flag or break down through the lower flag trendline.

Do you see now how we can make simple rules regarding the trend and flag patterns in order to create a cohesive trading plan?

When a stock is trending, it typically does so in steps...or flags. Therefore, by identifying trending stocks, we're de facto going to find flags too.

The key now is how to find trending stocks and flag patterns at will. The problem many people have with trading a winning position is that they're scared they won't find one ever again. Therefore they stay in too long and eventually they end up forfeiting their losses. Does that sound at all familiar?!

Well the good news is that we have developed some sophisticated algorithms that find trending stocks, whether they're up or down.