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Are all flag patterns created equal? Sure, they can come in different shapes and sizes, but as far as how to trade them, a flag is a flag, right?
For the most part, these patterns represent a continuation of the current trend. So if the market is trending higher and forms a flag, chances are it will break to the upside. The opposite applies to a market in a downtrend.
But here’s the thing, a flag is only a continuation pattern if it forms at an angle that is against the current trend. If it slopes with the trend, it doesn’t fit the mold.
What does this mean for you?
It means that if you aren’t paying attention to how and where they form within a trend, you are killing your profit potential. What’s worse is that you are likely to get caught on the wrong side of the market.
By the time you finish reading this lesson, you will know what constitutes a sloping flag pattern, how to differentiate them from traditional flags, and know exactly how to trade them.
Before we get into the importance of sloping flags, it’s important that you understand how and why the traditional flag pattern forms.
As I mentioned above, bull and bear flags alike are most often traded as continuation patterns. They are one of my favorite technical structures to trade because they typically offer favorable entries and precise targets.
The most profitable bullish or bearish flags form within a strong trending market where either buyers or sellers begin taking some profit off the table. This profit taking causes the market to pullback against the trend which offers an opportunity for new participants to enter.
Here are two great examples. Let’s start with the bull flag.
Now, I’ll be the first to admit that the AUDCHF bullish flag above wasn’t the cleanest of patterns. However, it was profitable. I know because I traded it.
Notice how after the pair had made an extended move higher, buyers began to take profit, and thus the pair pulled back at a moderate angle relative to the initial push higher.
And now for the bear flag. As you might expect, it’s the exact opposite of the bull flag we just studied.
So why do these price patterns form?
For starters, they represent consolidation. As you may well know, a healthy trend is one that pauses from time to time to rid itself of the short-term traders and accumulate new buyers or sellers.
This scenario makes sense when you think about the last time you caught a profitable trend. You likely didn’t catch the whole move but rather entered after it was established and exited before it ended.
That same cycle of buying and selling happens throughout the life of a trend. During times of consolidation, this exchange of hands becomes amplified as participants book profits or establish additional positions.
As price action traders, it’s times like this that we need to be on high alert for favorable breakout opportunities. It allows us to catch the trend as it resumes and gives us the ability to protect our capital with a strategically placed stop loss.
Now that we’ve identified the Forex flag pattern let’s move on to the meat and potatoes of today’s lesson.
Things get a bit tricky from here on out. But don’t worry, none of this is overly complicated.
It gets tricky because the flag of the sloping flag looks the same as it does with the traditional pattern we just discussed. The only difference is the angle at which the structure develops. More on this shortly.
Now, here’s why I caution Forex traders about being misled. In recent weeks, I have seen two well known Forex publications release commentary where a sloping flag was mistaken for a bull flag pattern.
But I get it; mistakes happen, and we’re all human. With that said, it’s important for you to know the difference so you can form your own opinion and avoid falling into the same trap.
The first occurred on the EURUSD 4-hour chart.
Notice how the so-called bull flag pattern formed with the trend and not against it. This is NOT what you want to see if you’re thinking of buying or currently have a long position.
Sure enough, the next 24 hours resulted in a break of channel support.
The formation above was, in fact, an upward sloping flag and thus represented trend exhaustion more so than a continuation of the current uptrend.
For this pattern to be considered a bullish continuation, the consolidation area would need to have faced away from the momentum.
The second example is a much larger and more prominent upward sloping flag than the one we just viewed on the EURUSD 4-hour chart. I even wrote commentary about this very pattern that formed on the AUDUSD daily time frame.
The very first thing to notice about the formation above is the angle at which it formed. A rally had been in place for several months, yet instead of consolidating in the opposite direction of the trend, it developed in the same direction.
Also, note the false break above resistance. Had you known about the implications of an upward sloping flag you could have avoided buying that break and getting trapped on the wrong side of the market.
The angle of the structure above was cause for concern if you had been a buyer during this time.
Why is that?
Because sloping flags are very similar to rising and falling wedges, which often signal a reversal. Think of them as another exhaustion pattern.
Now, that doesn’t mean that every structure such as the one above is going to break in the opposite direction of the trend. Like any other technical structure we trade, there will always be exceptions to the rule.
But being a great trader is about stacking the odds in your favor. So knowing what happens more often than not puts you one step closer to consistent profits.
For those of you who need to know why something occurs in additional to the how and what (which I’m also guilty of), it all comes down to the exchange of hands. I mentioned this term above, which simply means the buying and selling that takes place within a specified period.
We know that consolidation occurs at intervals within a trending market. But if you want to become a great trader, it’s as important to understand what is taking place as it is to know how to trade it.
So let’s take a step back and view a pair in a strong downtrend.
As mentioned at the beginning of this lesson, these consolidation periods can develop in different shapes and sizes, but one thing that is almost always true is that continuation patterns form against the trend.
Why does it happen this way?
It happens because there are more traders interested in booking profits than there are traders who are interested in taking fresh short positions. Said another way, the buying (demand) of the base currency outweighs that of the selling (supply) during consolidation. The opposite holds true for the quote currency.
Last but not least is the angle at which the consolidation forms. Notice how each move lower formed at a steeper angle than that of consolidation. This disparity is a sign of a “healthy” consolidation period and one that is likely to lead to a continuation of the current trend.
Now, what happens when sellers don’t liquidate and thus hinder the ability for new participants to sell at inflated prices?
You guessed it – we get a sloping flag pattern, an example of “unhealthy” consolidation.
Bull and bear flags come in all shapes and sizes, but one thing that can never falter is the angle at which the pattern forms. That is, whether it develops with or against the momentum.
Always remember that to be considered a continuation pattern, the flag must point in the opposite direction of the prevailing trend. If it doesn’t, there’s a good chance it’s hinting at a forthcoming reversal.
Last but not least, no technical pattern or strategy is immune to exceptions. So while the sloping flag typically signals exhaustion, there will be times where it breaks in the direction of the major trend.
Are you ready to begin trading flag patterns?
Then you will want to download the free PDF checklist that I put together based on my own experience.
In it, I will show you the three steps that I use when trading any flag pattern. I will even show you how to trade the sloping flags we just covered.
Click the link below and enter your email to download the checklist.
Justin Bennett is an internationally recognized Forex trader with 10+ years of experience. He's been interviewed by Stocks & Commodities Magazine as a featured trader for the month and is mentioned weekly by Forex Factory next to publications from CNN and Bloomberg. Justin created Daily Price Action in 2014 and has since grown the monthly readership to over 100,000 Forex traders and has personally mentored more than 3,000 students.Read more...
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