Bullish Flag Stock Chart Pattern

Implication

A Flag (Bullish) is considered a bullish signal, indicating that the current uptrend may continue.

Description

A Flag (Bullish) follows a steep, or nearly vertical, rise 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 downtrend.

The vertical uptrend, that precedes a Flag, may occur because of buyers' reactions to a favorable company earnings announcement, or a new product launch. The sharp price increase 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. This might occur, for example, in the days following a positive product announcement, when the excitement is starting to subside, and fewer buyers are willing to pay the high price that was commanded just a few days before. But, at the same time, sellers are unwilling to sell below a lower support limit.

A bullish signal occurs when the price rebounds beyond the upper trendline of the Flag formation, and continues the original upward 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 uptrend.

The Psychology behind Bullish Flag Pattern

A Bullish Flag pattern takes place because prices seldom move higher in a straight line for an extended period. During a sharp price movement, prices will typically take brief pause periods to "catch their breath" before continuing their move.

During the 1st stage of the Bullish Flag pattern (Flagpole part), as a result of positive market reactions toward some favorable events (e.g. positive earnings surprises, upward guidance, new product launch, etc.), prices keep on soaring sharply as new buyers, who were caught-up in the euphoria at that moment, are willing to buy at even higher prices.

As the prices rises, some early buyers who have bought the stock at lower levels would begin to sell to take profits. At this point, the 2nd stage of the Bullish Flag pattern begins (i.e. the Flag part).

At first, most of the stocks sold by the early buyers are easily absorbed, since the news and market sentiments are still very positive. Nevertheless, as time passes, buying pressures abated and fewer buyers are willing to purchase at the current, high price. Consequently, the prices begin to decrease gradually, but the decrease is slow and volume is diminishing, as the bullish sentiment is actually still very strong.

After some time, just as it starts to look as if a real decline is underway, a new positive development comes out. As a result, the price begins to move higher and break out through the upper line of the Flag with a surge in volume, as new buyers now have overwhelmed those taking profits.

In the following days, there might be more positive news and/or “buy” recommendations coming out, leading the prices to lead to escalate even higher.

Important Characteristics

Following are important characteristics for this pattern.

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.

Volume

As the Flag develops, the volume tends to decrease. Following a positive product announcement, the price may have reached an unexpected high, and fewer buyers will be willing to buy. Interest in the stock may resume, however, as prices drop, and sellers begin to lower their price. The increased activity explains why you will often notice a sharp spike in volume at the end of a Flag.

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."

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 sharp increase in 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 increase. 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 uptrend.

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 an uptrend. The price has gotten ahead of itself with a steep rise; therefore market activity takes a break before continuing the uptrend. This pause is reflected in the decreasing trading volume. Similarly, a spike in volume marks the resumption of the uptrend.

Implementation

The two variations of bullish flags are shown in the United States Oil Fund (USO) (Click to Enlarge), which is an exchange traded fund that tracks the price of crude oil. Notice how two of the bullish flags are slanted, with downward sloping support and resistance levels. The flag in the middle is horizontal, with well-defined support and resistance levels.


This example illustrates how bullish flags can repeatedly form within a bullish trend. It also shows the different time periods over which flags can form, from relatively longer periods to incredibly short periods. The third flag in the USO formed in a matter of days, yet it led to an explosive move higher.

Example


Hewlett Packard chart provides an example of a flag that forms after a sharp and sudden advance (Click to Enlarge).

• Sharp Move: After consolidating for three months, HWP broke above resistance at 28 to begin a sharp advance. The 5-April high and 16-Feb trend line marked resistance and the breakout occurred with a volume expansion. The stock advanced from 28 to 38 in a mere 4 weeks. (Note: It is also possible that a small pennant formed in early May with resistance around 31).
• Flagpole: The distance from the breakout at 28 to the flag's high at 38 formed the flagpole.
• Flag: Price action was contained within two parallel trend lines that sloped down.
• Duration: From a high at 38 to the breakout at 36, the flag formed over a 23-day period.
• Breakout: The first break above the flag's upper trend line occurred on 21-June without an expansion of volume. However, the stock gapped up a week later and closed strong with above-average volume (red arrows)
• Volume: To recap - volume expanded on the sharp advance to form the flagpole, contracted during the flag's formation and expanded right after the resistance breakout.
• Targets: The length of the flagpole measured 10 points and was applied to the resistance breakout at 36 to project a target of 46.

Sources and Additional Information:


http://www.trending123.com/patterns/bull_flag.html
http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:chart_patterns:flag_pennant_continu
http://www.tradingpricepatterns.com/bullish-flag/
http://chart-patterns.netfirms.com/bullflag.htm
https://www.istockanalyst.com/article/viewarticle/articleid/1075360

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