Of all the patterns created by price action, the flag and pennant pattern are some of the easiest to recognize as well as trade. They provide excellent entry and exit points with defined risk and reward scenarios.
Below we’ll compare their differences in both appearance and trading tactics.
Flag Pattern
A popular trading pattern for both long and short traders is the flag pattern. The flag pattern is a trend continuation pattern that usually happens after a big push up or down first thing when the market opens.
After the push up, shares slowly drifted down on lighter volume forming a rectangular shape before breaking out to the upside in continuation of the original move.
Ideally you would like to see volume pick up as shares break out but it doesn’t happen all the time. Profit targets on flag patterns is typically set for the same amount as the initial move.
This pattern also works great on the short side with the reverse formation of a bull flag setup. We would see a sharp selloff followed by an upward rectangular pattern forming before breaking out to the downside through the support.
When trading these setups you’ll want to wait and make sure the breakout candle closes above the resistance/support level to confirm the move. Sometimes you will see it push up and then quickly come back down signaling a false breakout.
These are great patterns to watch for as they are a high probability setup that offer great risk/reward.
Flag Pattern Example
As you can see in the chart above, Apple shares ($AAPL) took off at the open with a slight pullback; creating a perfect example of a bull flag pattern.
When trading a flag pattern the entry is always after it breaks the consolidation phase in favor of the original move. Stops can be handled two different ways depending on your style.
The first stop could be a close back inside the consolidation zone marked off by the trends lines. The second stop, which is what we use most, is just below the low in the pullback. The second stop helps filter out any noise like a quick drop back into the consolidation zone before popping back up which would trigger the first possible exit point.
Pennant Pattern
The pennant pattern is another great setup that is very similar to the flag pattern but instead usually forms a triangular pattern.
Shares generally make a sharp move either up or down and then consolidate in the form of a pennant with descending resistance and rising support.
When shares break out from this pattern it can be powerful as seen in the chart above of Facebook.
You can trade this pattern as a short or long setup but as with the flag pattern it is always good to make sure the breakout candle closes above the support/resistance to confirm the move and there is an increase in volume on the breakout candle.
Tips for Trading Flags and Pennants
Tip 1: Use volume as your guide for making entry and exit decisions.
Volume is one of the best indicators in technical analysis. When used correctly it will help confirm breakouts/breakdowns and the momentum behind those moves. Obviously, the more volume, the better on breakouts. Increased volume means traders were waiting for the breakout and looking get in for the ride too. This creates momentum and can lead to bigger price movements.
Tip 2: Don’t force a trade.
If the pattern isn’t setting properly with a defined pattern, increased volume, etc. then you need to move along. There are plenty of these setups happening everyday so there is no sense it trying to force it.
Tip 3: Exercise patience and let the trade come to you.
Jumping in a trade before the breakout is a sure way to lose money. Wait till the stars align and the odds are in your favor before putting your capital in the trade.
Tip 4: Always place stops and have profit targets in mind.
One of the most common traits all successful traders have is the ability to manage risk. This is one of the first things developing traders should focus on. If you don’t understand how to protect your money then you are at a major disadvantage.
Bottom Line
These are great patterns to trade and offer plenty of upside for the risk taken. If you miss the big initial move first thing in the morning you can always sit back and wait for one of these patterns to take place for a continuation.
Flags may be a little trickier to see but with some practice you’ll understand what and when to look for it.