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Technical Analysis: Trading Bull Flags

  • Written by Syndicated Publisher 286 Comments286 Comments Comments
    July 1, 2010

    From Elliott Wave Global Market Service

    A Bull Flag is typically viewed as bullish continuation signal. The pattern indicates that the preceding up trend may continue.

    A Flag (Bullish) most often follows a steep rise in price, and consists of two parallel trend lines that form a rectangular flag shape. The flag pattern can be horizontal (as though the wind is blowing it), however it more often has a slight down trend. The up trend that occurs prior to the formation of the flag may be due to a number of factors including an earnings announcement, product launch or many others. This preceding sharp rise in price is sometimes referred to as a flagpole.

    The rectangular shape of the flag is typically representative of a period of consolidation. This consolidation happens when the price essentially becomes range-bound and appear to move to between an upper and lower price limit. A bullish signal then occurs when the price rebounds beyond the upper trend line of the Flag formation, and it continues the preceding upward price trend. Once this takes place it is considered a pattern confirmation.

    Distinctive Attributes

    Trend Lines

    The price trend lines tend to run parallel, whereas with a Pennant, the price trend lines tend to converge in a contracting triangular manner.

    Volume Patterns

    As the flag pattern develops, volumes tend to reduce. Following the previous up trend and the associated reasons for that rise, prices may reach a level where fewer buyers are willing to buy. As prices come off the highs, sellers tend to consider lower offer and begin to lower their price. This subsequent increase in activity explains the reason why a sharp spike in volume often happens at the end of a flag pattern.

    Pattern Duration

    Bull flag patterns are best formed in periods of 3 weeks or less. These patterns tend to form somewhere between 5 days and 30 days typically. The more successful patterns tend to be less than 3 weeks in duration however.

    Trading Considerations

    Possibility of Price Reversal

    In some rare cases, the price will break against the original price movement, and create a reversal trend. The pattern reversal may be signalled during the Flag formation by a sharp increase in volume, as opposed to the more typical decrease.

    Duration of the Pattern

    The duration of the pattern depends on the extent of the price fluctuations (consolidation). The greater the fluctuations, the longer a pattern will take to develop.

    Target Price

    It is commonly held that the length of the flagpole indicates the potential price increase. When the Flag completes, the price typically jumps to replicate the height of the original flagpole, whilst continuing in the direction of the inbound trend.

    Criteria that Supports

    Volume

    Volume should diminish noticeably as the pattern forms.

    A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly over and above the average of the volume for the duration of the pattern. In addition, the volume over the course of the pattern should be declining on average.

    Criteria that Contradicts

    Pattern Duration

    A pattern that exceeds “4 weeks to develop should … be treated with caution”. After 4 weeks, interest in the stock is likely to decrease to point that it is unlikely to continue in a strong up trend.

    Breakout Without Support Volume

    The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. Further, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable and may actually reverse.

    Long Preceding Trend

    When you observe this formation, and a price continuation occurs, it is best to use the flagpole as a “yard-stick” to indicate the level at which to “take profits, step aside, and watch for further chart developments.”

    Underlying Behavior

    This pattern is effectively a pause in an up trend. The price has moved ahead of itself with a steep rise; therefore market activity takes a break before continuing the up trend. This pause is reflected in the decreasing trading volume. Similarly, a spike in volume marks the resumption of the up trend.

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