In this post, we will be explaining what a flag patterns is and how to identify and trade them.
What is a Flag?
The flag pattern is the most common continuation patterns in technical analysis. It often occurs after a big impulsive move. The impulse move is followed by short bodied candles countertrend to the impulse move, which is called the flag. It is named because of the way it reminds the viewer of a flag on a flagpole.
Often, the breakout of the flag is the same size as the impulse leading to the flag. We can use this to create our take profit levels.
There are 2 types of ways we can trade flag patterns; Risky Entry & Safe Entry. See below for the pros and cons for both and how to enter them
The reason why it is called a risk entry is because we haven't got many confirmations apart from the bounce off the fibonacci level. Price may have the potential to go lower for a deeper correction before moving up. Whereas for the safe entry, the confirmation that it is a valid flag would be the break of the flag pattern.
How to trade using Risk Entry: Wait for price to bounce off the fibonacci levels (0.5 or 0.618) and then enter with stops below/above the correction.
One of the advantages of doing a risk entry is that we can have small stop loss and have a great risk:reward ratio. Also, we can gain an entry at the start of the move and HODL!
Safe Entry:
Safe entry requires more than one confluence and requires confirmation. We have the rejection of the fibonacci level as well as a breakout of the flag, confirming that it is a valid flag pattern.
How to trade using Safe Entry: For a safe entry, enter upon the break of the flag pattern with stops above/below the flag depending on whether its a bull or a bear flag. First TP would be the recent structure level and second TP would be the length of the impulse which led up to the correction.
The disadvantage to using a safe entry is that we require a bigger stop loss which makes the risk:reward ratio not as great as the risk entry. However, the probability of the trade succeeding is higher.