Bear Flag Classic Stock Trading Pattern

Implication
A Flag (Bearish) is considered a bearish signal, indicating that the current downtrend may continue.

Description
A Flag (Bearish) follows a steep or nearly vertical decline in price, and consists of two parallel trendlines that form a rectangular flag shape. The Flag can be horizontal (as though the wind is blowing it), however it often has a slight upward trend.

The vertical downtrend, that precedes a Flag, may occur because of buyers’ reactions to an unfavorable company announcement, such as a court case, or a sudden and unexpected departure of a CEO. The sharp price decrease is sometimes referred to as the "flagpole" or "mast".

The rectangular flag shape is the product of what technical analysts refer to as consolidation. Consolidation occurs when the price seems to bounce between an upper and lower price limit. The Flag (Bearish) pattern formation reflects the reaction of sellers who are willing to sell at a lower cost, and the influx of buyers who inadvertently drive up the price as they compete to buy at the best possible price.

A bearish signal occurs when the price rebounds beyond the lower trendline of the Flag formation, and continues the original downward price movement. This is considered a pattern confirmation.

When speaking about Flags, technical analysts may use jargon and refer to the flag as "flying at half-mast". Visually, this reference is nothing like a flag at half-mast, such as on a day of national mourning. Instead, this term refers to the location of the flag - at the mid-point of what would otherwise be a continuous downtrend.


Important Characteristics
Following are important characteristics for this pattern.


Sharp Move
To be considered a continuation pattern, there should be evidence of a prior trend. Flags and pennants require evidence of a sharp advance or decline on heavy volume. These moves usually occur on heavy volume and can contain gaps. This move usually represents the first leg of a significant advance or decline and the flag/pennant is merely a pause.

Flagpole
The flagpole is the distance from the first resistance or support break to the high or low of the flag/pennant. The sharp advance (or decline) that forms the flagpole should break a trend line or resistance/support level. A line extending up from this break to the high of the flag/pennant forms the flagpole.

Flag
A flag is a small rectangle pattern that slopes against the previous trend. If the previous move was up, then the flag would slope down. If the move was down, then the flag would slope up. Because flags are usually too short in duration to actually have reaction highs and lows, the price action just needs to be contained within two parallel trend lines.

Pennant
A pennant is a small symmetrical triangle that begins wide and converges as the pattern matures (like a cone). The slope is usually neutral. Sometimes there will not be specific reaction highs and lows from which to draw the trend lines and the price action should just be contained within the converging trend lines.


Trendlines
Flags are very similar to Pennants. However, with a Flag, the price trendlines tend to run parallel, whereas with a Pennant, the price trendlines tend to converge. John J. Murphy notes that a price drop below the lower trendline may indicate the resumption of the downtrend.

Volume
Volume should be heavy during the advance or decline that forms the flagpole. Heavy volume provides legitimacy for the sudden and sharp move that creates the flagpole. An expansion of volume on the resistance (support) break lends credence to the validity of the formation and the likelihood of continuation.


Duration of the Pattern
Martin Pring notes in his book, Technical Analysis Explained that "Flags can form in a period as short as 5 days or as longs as 3 to 5 weeks." John J. Murphy identifies that Flags "often last no longer than one or two weeks."

Once a flag becomes more than 12 weeks old, it would be classified as a rectangle. A pennant more than 12 weeks old would turn into a symmetrical triangle. The reliability of patterns that fall between 8 and 12 weeks is debatable.

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 signaled during the Flag formation by a pattern of increasing 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 decrease. When the Flag completes, the price typically jumps to replicate the height of the original flagpole, while 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 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 Refutes

Duration of the Pattern
According to Martin Pring, 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 downtrend.


No Volume Spike on Breakout
The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, 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 Inbound Trend
Shabacker writes that, "When a mast is long ... and it’s Flag relatively small, we should naturally expect the movement to be pretty well exhausted when its indicated objective is reached." He suggests that 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 a downtrend. The price has gotten ahead of itself with a steep rise; therefore market activity takes a break before continuing the downtrend. This pause is reflected in the decreasing trading volume. Similarly, a spike in volume marks the resumption of the downtrend.

Examples - Click to Enlarge:


Sources and Additional Information:
http://www.trending123.com/patterns/bear_flag.html
http://chart-patterns.netfirms.com/bearflag.htm
http://www.thestockbandit.com/Bear-flag.htm
http://www.stocks-simplified.com/bear_flag.html

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