A commonly used pattern, the flag pattern occurs when there is a short-term price divergence from a long-term trend. Because the price action on the chart resembles a flagpole and flag, it is called a flag pattern. It occurs when the price of a financial asset temporarily moves against the current trend, forming a rectangular shape on the chart. The price is stuck in a narrow range until the trend finds its direction again, and the consolidation period is usually short-term.
A flag pattern has two parts, the flagpole and the flag. The flagpole represents the sharp price movement that occurs before the formation of the flag pattern. The flag is the rectangular shape formed by price fluctuations in a narrow range. Investors interpret the flag pattern as the opening of a position in the direction of the previous trend.
There are two flag patterns, the bullish flag pattern and the bearish flag pattern.
In a bullish flag pattern, when there is a sharp upward price movement (flagpole), the price of the relevant financial asset starts the consolidation process, and a rectangular shape (flag) is formed on the chart. When a flag pattern occurs, investors expect the uptrend to continue after a relatively short-term retracement period.
The bearish flag pattern is the opposite of the bullish flag pattern. After a sharp downward movement (flagpole), the price is stuck in a narrow range, and on consolidation, a rectangular shape (flag) occurs on the chart. As the flag pattern is formed, a low-volume increase in the price of the relevant financial asset occurs. Investors interpret the bearish flag pattern as the price will move according to the trend, that is, downwards, after the low-volume upward movement (flag).
Analysis
When investors analyze a flag pattern, they look for specific features to confirm its validity. And these features are as follows:
Investors pay attention to the fact that the price of the asset has moved sharply before the consolidation period. In other words, they pay attention to the fact that the flagpole is upright and strong, which means that there is strong momentum in the current trend.
Investors expect the emerging flag pattern to be relatively short-term because the price may potentially move in the direction of the previous trend.
Investors expect that during the period when the price is squeezed in the formation (when the flag is formed), the volume of the financial asset will be low compared to the previous trend period. A squeeze in price or a drop in volume means that the market is stalling and that investors are holding their positions instead of actively trading.
After confirming the validity of a flag pattern, investors usually place buy/sell orders at the breakout point of the flag pattern. The breakout point is the point at which the price falls above or below the upper or lower trendline of the flag pattern. Investors interpret the breakout point as the entry point to the market.
In short, when analyzing a flag pattern, investors look for a steep and strong flagpole, a relatively short squeezing period, and other technical indicators before trading. Moreover, flag patterns are considered continuation patterns, so the price is expected to continue in the direction of the previous trend after a flag pattern is completed. However, it is also important to follow key indicators such as the stock’s other technical indicators (volume, moving average, etc.) to make an informed decision.
