How to trade bull and bear flag patterns?

In technical analysis, the flag pattern indicates short-term price movements within the parallelogram that counteract the previous long-term trend. Traditional analysts view flags as potential indicators of trend continuation.

There are two types of flag patterns: bullish flag and bearish flag. Although their results vary, each flag has five key characteristics, listed below:

  1. Strong prior trend (flagpole or pole)
  2. Consolidation channel (flag itself)
  3. Trading volume model
  4. Breakthrough
  5. Confirmation that the price is moving in the direction of its previous trend.

In this article, we will discuss bullish and bearish flag patterns and how to trade them.

What is a bull flag pattern?

A bull flag is a technical pattern that occurs when the price consolidates inside a down channel after a strong uptrend. The mentioned channel consists of two parallel ascending trend lines. Please note that the pattern may be a wedge or a pennant if the trend lines are converging.

Volume usually decreases during consolidation, meaning that traders associated with the prior trend are less likely to buy or sell during a consolidation period.

bull flag illustration

The urgency of new and old investors, or “FOMO” (fear of missing out), usually returns when the price breaks above the bull flag’s upper trend line, thereby increasing trading volumes.

As a result, analysts see high volume as a sign of a successful bull flag breakout.

On the other hand, lackluster volumes when the price breaks above the upper bull flag trendline increase the chance of a false positive. In other words, the price is at risk of falling below the upper trend line, thereby nullifying the bullish continuation setup.

Trading with a bull flag

Traders may go long at the bottom of the bull flag in anticipation that the next uptrend in price to the upper trendline will result in a breakout. More risk-averse traders can wait for the breakout to be confirmed before going long.

In terms of an up target, a breakout of the bull flag will usually cause the price to rise by an amount equal to the size of the flagpole as measured from the bottom of the flag.

The following Bitcoin (BTC) price pattern between December 2020 and February 2021 shows a successful bull flag breakout setup.

Daily BTC/USD price chart. Source: Trading View

As a word of caution, traders should support their risk by placing a stop loss just below the entry level. This will allow them to cut their losses if the bull flag becomes invalid.

What is the bear flag pattern

The bearish flag pattern is the opposite of the bullish flag pattern, showing an initial down move followed by an upward consolidation within a parallel channel. The downward movement is called a flagpole, and the upward channel of consolidation is called the actual bearish flag.

At the same time, the period of the formation of a bearish flag, as a rule, coincides with a decrease in trading volumes.

Bear flag illustration

Trading the bear flag pattern

Below is an illustration of how to trade the bear flag pattern on crypto charts.

Daily BTC/USD price chart with bear flag breakout. Source: Trading View

In the Bitcoin chart above, the price formed a flagpole followed by an upward pullback inside an ascending parallel channel. Eventually, the price of BTC breaks out of the channel range down and falls to the height of the flagpole.

Traders can go short on the pullback from the upper trend line of the flag, or wait until the price breaks the lower trend line with increasing volumes.

In any case, the short target is usually measured by subtracting the peak of the flag from the size of the flagpole.

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Meanwhile, a break below the flag’s lower trendline accompanying the lackluster volume suggests a false exit, meaning price could re-establish the lower trendline as support for a potential bounce inside the parallel channel.

To limit losses in case of a fake 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 step involves risk, and readers should do their own research when making a decision.

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