How to Use Flag Chart Pattern for Successful Trading? | My Espresso

Flag Chart Pattern: How to use it for Successful Trading?

Whether you are a seasoned or a new investor, it is wise to understand important technical and fundamental analysis methods for successful trading. One such method is the flag chart pattern. In terms of stock trading, a flag chart pattern helps spot the potential continuation of a preceding trend from the point of the price change against a similar trend. Flag pattern trading assumes that if this trend continues, the price of the security concerned will rise sharply, resulting in high profits for the investor.

Published on 25 January 2022

Here is a quick guide on the flag chart pattern and how to use it for successful trading:

What is a Flag Chart Pattern?

A flag chart pattern is typically a price chart that depicts the potential of a sharp counter-trend (called the flag) following a brief price trend (known as the flagpole). Flag patterns are formed when the market integrates with a narrow range after a sharp price move. However, the pattern is considered complete when the subsequent price movement follows the same direction as the first price move.

Flag patterns can help investors identify price trend reversals or breakouts after a period of market consolidation. The pattern is known as the flag pattern because of its appearance – the small rectangle characterised by the market consolidation and its connection to the pole indicating large and quick price moves.

What are the Characteristics of a Flag Pattern?

The flag part of the chart runs between parallel lines. However, the direction of the flag can be slanting, downward or sideways. Flags that move in the same direction as their predecessor indicate a low potential for traders. Ideally, you should find a pattern with a high sharp move, accompanied by a sideways flag or a downward angled flag.

Alternatively, if the move is low instead of high, you should consider trading a flag that is sideways or angled higher, moving in the opposite direction of the trend.

Flat pattern trading gives a small risk ratio, implying higher chances or profits and less risk. The flag chart pattern can be bearish or bullish and usually consist of five to twenty price bars (also known as candlesticks).

How to Use Flag Pattern for Trading?

Using the flag chart pattern, you can create a potentially profitable strategy for trading by spotting the three key points:

  • Entry point: As per financial experts, you can consider entering a trade on the price break dayHowever, be mindful that the price break should also close above the upper parallel line of the trend. Alternatively, in a bearish flag chart pattern, enter the trade one day post the closing of the price below the lower parallel trend line. 
  • Stop loss: Place your stop loss consider the opposite side of the flag chart pattern. For instance, if the upper trend line of the flag chart pattern is at ₹50/share, and the lower trend line is at Rs. 46 per share, the price level below ₹46 would be the ideal stop-loss point for the trade.
    Also Read: Stop Loss Strategy
  • Target profit: If you do not want to take a high risk, use the difference (in terms of price) between the parallel lines of the flag chart pattern to set your target profit mark.

For example, if your breakout entry point for a trade is ₹50, and there is a difference of ₹4 in the parallel line of the flag chart pattern. You can consider placing a target profit at ₹54. However, if you can take a high risk in trading, you can follow a more optimistic approach to set a profit target. For instance, if the lowest flagpole price is ₹40 and the highest flagpole price is ₹65, and the entry breakout point is ₹50, the target profit mark can be set at ₹75 (50+25). 

Trading in a Bullish Flag Pattern

A potential buy signal forms when the price moves higher and then consolidates, creating a channel of support and resistance. At this point, the stock price is above the upper resistance line. The pattern is complete when the price breaks out but maintains the same direction as the previous trend.

In this period, the flag chart pattern continues to maintain its course. To estimate the target area in a bullish flag pattern, use the length of the flag chart pattern and apply it to the resistance line. The opportunity for successful trading occurs when the sideways pattern strikes after a sharp price increase.

Trading in a Bearish Flag Pattern

Trading in a bearish flag chart pattern is the opposite of the bullish flag pattern. This flag chart pattern assumes that the prices have been low previously, and a potential buy signal occurs post a period of price consolidation. The price generally closes below the support line. You should place a stop loss on the high point of the flag if you see any downside break out of any short-trade. To estimate the target area, you can use the length of the flagpole that is below the support line of the flag.

Conclusion

Overall, using flag chart patterns can be helpful in successful trading, provided you pay close attention to the market trends and position size selection. Alternatively, you could consider engaging with a professional broker to help you identify profitable trading opportunities in different market scenarios.
Also Read: 6 signals to take profits off the table when trading

Chandresh Khona
Team Espresso

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