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Table of Contents:
- What is a bull flag?
- Five characteristics of a bull flag pattern
- What does a bull flag look like?
- Advantages and disadvantages of a bullish flag
- Bull flag trading tips
- The bottom line
What is a bull flag?
Stock trading is full of technical indicators, chart patterns, and signals which help traders identify trends in the stock market and recognize price movements for optimal entry and exit points. Understanding patterns can be a beneficial tool when figuring out how stocks work, though even when used in combination with other resources, stock trading is still a high-risk activity.
The bullish flag pattern gets its name because it resembles a flag on a flagpole. A steep vertical rise in price is followed by a period when the price remains bounded between 2 fairly close, roughly horizontal lines. The pole represents the steep rise in price, and the flag represents the area between the 2 lines.
The bull flag pattern is thought to suggest an uptrend: that when the price of the stock leaves the area between the 2 lines, it will continue upwards. This makes it a continuation pattern, which is a pattern that is thought to suggest that the price will continue to move in the same direction.
If a trader has decided to buy as soon as the price rises out of the flag area, the next question is when should they sell. This is called a profit target. Like other trading decisions, this will likely depend on more than just stock patterns. That said, a common profit target is the base of the flag plus the height of the pole.
- The flag pattern consists of a flagpole with a rectangular pattern that resembles a flag on a pole. The flag must not be any more than half the size of the pole.
- The flag develops off the flag pole as parallel lines form the flag. The more condensed those lines are, the stronger the signal.
- A flag pattern takes time to develop. They are not useful until their upper and lower trendlines are clear. Even then, as with any investment, there could always be a negative outcome.
Five characteristics of a bull flag pattern
Although technical analysis of trading patterns can be helpful, they can also be challenging to identify. Keep an eye out for the following when looking for a bull flag pattern:
- The preceding trend
- The consolidation period
- The volume pattern
- A breakout
- A confirmation showing the price moving in the same direction as the breakout.
The first step in identifying the pattern is to locate the pole, which is representative of a significant rise in the stock price and is the starting point in the formation of the pattern.
Once the pole is found, identify the range of consolidation or wavering in the price of the stock (this is the flag). Prices will likely fluctuate during this stage before they begin trending upwards, assuming the bull flag does what is expected. This is because the consolidation creates a resistance line at the higher end, while the lower end is the support line. When the stock price rises above the resistance level and continues in an upward trend, the pattern has been established.
Volume may increase first and then decrease as the formation reaches the endpoint. There may be an uptick in volume during the breakout, although it may be minimal. The trend ends with the price moving in the same direction as the breakout.
Bull vs. bear flag
The pattern formed by inverting the bull flag stock pattern is called the bear flag stock pattern.
The bear flag starts with a significant fall in prices, followed by a period when the price remains between 2 lines. It is thought that the bear flag suggests the price will continue to move downward once it leaves the area between the 2 lines.
What does a bull flag look like?
The bull flag pattern closely resembles the shape of a flag on a pole. The flag can take the shape of a horizontal rectangle and is often angled in a downward position away from the trend.
Identifying the bull flag pattern doesn’t have to be complicated. These steps can help.
- Identify an uptrend, as the bull flag pattern is a continuation pattern.
- When the correction begins, there should be a price drop.
- As the pattern is retraced, the line should not move below half of the pole. If it does, it’s not considered a flag trading pattern.
- The pattern should have parallel lines to form the flag.
- As it reaches the endpoint, the price should break above the top boundary of the flag pattern.
Another pattern that resembles the bullish flag pattern is called a pennant. Instead of developing parallel lines to form the flag, the lines converge during the consolidation period. As you’d expect, the pennant looks like an elongated triangle with the 2 sides of the pennant equal and meeting at the tip. The formation of both the flag pattern and the pennant may take weeks to form.
Advantages and disadvantages of a bullish flag
As with any pattern, there are advantages and disadvantages. One advantage is that it might give an accurate prediction, and a disadvantage is it might give an inaccurate prediction. More specific disadvantage to the bull flag is that even if your trade does eventually work out in your favor, it might take a long time to come to fruition.
An advantage of the bull flag is that it suggests particular profit targets and allows for the setting of a tight stop loss, as explained below.
Bull flag trading tips
Investing has a lot of detailed information to learn, so when a strategy comes along that is simple to use, investors seem to gravitate to it, and despite the risks, the bull flag is a popular one.
To establish a trading strategy, identifying 3 key points can help.
- The entry. Although bull flags indicate a continuation of the current trend, making a move too early can be a mistake, as there is always the chance that an initial breakout could be a false signal. Waiting until the price breaks above the upper trend line may be your best bet.
- Stop-loss. Set a stop-loss point at the opposite side of the flag pattern. For example, if the pattern’s upper trendline is $60 per share, and the lower trendline is at $52, a logical stop order for a long position would be lower than $52.
- Profit target. To set a target in a bullish flag pattern, utilize the difference between the parallel trend lines.
Although these are key points to pay attention to, it’s also important to consider overall trends in the market to be sure you don’t misinterpret the signals.
The bottom line
The world of investing has a lot of moving parts. There are terms to learn, patterns to understand, and various ways to analyze the stock market and get comfortable trading. For most beginning investors, it all starts with the question, how do stocks work?
Learning patterns such as the cup and handle pattern, the head and shoulders pattern, golden cross pattern, and the bull flag pattern can help investors identify stock market trends and make better decisions about when to make trades.