How to trade bull and bear flag patterns?
2023.02.22 11:12
In technical analysis, a flag pattern indicates short-term price movements inside a parallelogram coounter to the previous long-term trend. Traditional analysts view flags as potential trend continuation indicators.
There are two types of flag patterns: bull flag and bear flag. While their outcomes are different, each flag exhibits five key characteristics, as listed below:
- The strong preceding trend (flagpole or pole)
- The consolidation channel (the flag itself)
- The trading volume pattern
- A breakout
- A confirmation of the price moving in the direction of its previous trend.
In this article, we discuss bull and bear flag patterns and how to trade them.
What is a bull flag pattern?
A bull flag is a technical pattern that appears when the price consolidates lower inside a downward-sloping channel after a strong uptrend. The said channel comprises two parallel, rising trendlines. Kindly note that the pattern could be a wedge or a pennant if the trendlines converge.
The volume typically dries up during consolidation, implying that traders associated with the preceding trend have less urgency to buy or sell during the consolidation period.
Bull flag illustration
The urgency to jump in by new and old investors, or “FOMO” (fear of missing out), typically returns when the price breaks above the bull flag’s upper trendline, thus boosting trading volumes.
As a result, analysts view strong volumes as a sign of a successful bull flag breakout.
On the other hand, lackluster volumes when the price breaks above the bull flag’s upper trendline increase the possibility of a fakeout. In other words, the price risks dropping below the upper trendline, thus invalidating the bullish continuation setup.
Trading a bull flag setup
Traders can enter a long position at the bottom of a bull flag in anticipations that the price’s next run-up toward the pattern’s upper trendline will result in a breakout. The more risk-averse traders can wait for a breakout confirmation before opening a long position.
As for the upside target, a bull flag breakout typically prompts the price to rise by as much as the flagpole’s size when measured from the flag’s bottom.
The following Bitcoin (BTC) price pattern between December 2020 and February 2021 shows a successful bull flag breakout setup.
BTC/USD daily price chart. Source: TradingView
As a note of caution, traders should maintain their risks by placing a stop loss just below their entry levels. That will enable them to reduce their losses if the bull flag gets invalidated.
What is a bear flag pattern
A bear flag pattern is the opposite of a bull flag pattern, exhibiting an initial downside move followed by an upward consolidation inside a parallel channel. The downside move is called the flagpole, and the upward consolidation channel is the bear flag itself.
Meanwhile, the period of bear flag formation tends to coincide with declining trading volumes.
Bear flag illustration
Trading a bear flag pattern
The following is an illustration of how to trade bear flag pattern on crypto charts.
BTC/USD daily price chart featuring a bear flag breakdown. Source: TradingView
In the Bitcoin chart above, the price has formed a flagpole followed by an upward retracement inside a rising parallel channel. Eventually, BTC price breaks out of the channel range to the downside and drops by as much as the flagpole’s height.
Traders can choose to open a short position on a pullback from the flag’s upper trendline or wait until the price breaks below the lower trendline with rising volumes.
In either case, the short target is, as a rule, measured by subtracting the flag’s peak from the flagpole size.
Related: What is a Doji candle pattern and how to trade with it?
Meanwhile, a breakdown below the flag’s lower trendline accompanying lackluster volumes suggests a fakeout, meaning the price may reclaim the lower trendline as support for a potential rebound inside the parallel channel.
To limit losses in a fakeout scenario, it is important to place a stop loss just above the entry levels.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.
