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What are Bull Flag and Bear Flag Patterns: All You Need to Know

2022-03-28 06:32:13

Flags are continuation patterns that allow traders and investors to perform technical analysis on an underlying stock/asset to make sound financial decisions. These patterns form when the price of a stock or asset moves counter in the short-term from the predominant long-term trend. Flag patterns are used to forecast the continuation of the short-term trend from a point in which the price has consolidated. Depending on the trend right before the formation of a shape, flags can be both bullish and bearish. Let’s have a closer look at the bull and bear flag patterns.

Bull Flag and Bear Flag PatternBull Flag and Bear Flag Pattern Traits

Every bull flag and bear flag pattern is characterized by six primary traits:

  1. Flag: The area of consolidation in price action that follows and counters a preceding a sharp price movement. The retracement of the flag should not be higher than 50% compared to the flag pole.
  2. Flag Pole: The distance from the point where the trend begins and stretches to the highest or lowest point of the flag. An ascending flag pole forms the shape of a bullish flag pattern.
  3. Breakout Point: The specific point at which the asset price moves above the resistance level. The breakout point is used by traders to confirm the identification of a flag and often serves as the entry point of a trade.
  4. Price Projection: The projected upward price movement of the asset after the breakout point is reached. Traders use the price projection as part of their risk-reward calculations and risk management strategies.
  5. Resistance Level: It refers to a declining level of resistance that is parallel to the support level (bull flags). On the other hand, it also represents an up-trending level of resistance parallel to the support level (bear flags).
  6. Support Level: It presents a declining level of support parallel to the resistance level (bull flags), or an increased level of support that is parallel with the level of resistance (bear flags).

 

What is a Bull Flag Pattern?

A bull flag pattern is a sharp, strong volume rally of an asset or stock that portrays a positive development. It forms when the price retraces by going sideways to lower price action on weaker volume followed by a sharp rally to new highs on strong volume. Traders favor this pattern because they are almost always predictable and true.

Example of a bull flag pattern

Example of a bull flag pattern with the BTC/USD trading pair (source: CoinDesk)

So, a bull flag pattern is characterized by an initial sharp rally and then by a period of consolidation. With most bull flag patterns, the volume increases when the pole is being formed, then drops during the period of consolidation. Though the following breakout does not always feature a high surge in volume, an increase in volume can show that there has been an influx of new buyers.

How Do Bull Flag Patterns Work?

Traders can profit from identifying bull flag patterns by going long on bullish trends. If the flagpole was formed by a move upwards, it forms a bullish flag. If the resistance of a bull flag is broken, traders can be more confident that the price will continue to move upwards by the length of the pole. On the other hand, if the support of a bull flag is breached, traders can deem that the pattern was invalid.

What does a Bull Flag Pattern look like?

The pattern of a bull flag is made up of parallel lines over the consolidation movement. When these lines converge in an upwards trend, they are typically called a bull pennant. To identify a bull flag pattern, traders can take the following steps:

  1. Identify the flag pole, which is the preceding sharp upturn that is typically complemented by increased volume as traders respond to the price movement.
  2. If the asset continues to move in the direction of the consolidation, it’s unlikely that the chart will form a bull flag pattern, as the trend of the flag pole has continued to reverse. If the asset instead moves in the direction of the flag pole, then a bull flag pattern has been identified.
  3. The point where the price movement breaks that of the flag is generally when traders place their orders. The length of the flag pole is typically used to calculate the profit target, though a more conservative strategy is to use the height of the flag pole instead.

Bull flags, like most continuation shapes, represent a bit more than a shorter lull in a bigger move. Hence, they usually form in the middle of the final move. Moreover, they occur as assets/stocks hardly move higher in a straight line for a long period because these moves are broken up by shorter periods.

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What is a Bear Flag Pattern?

A bear flag is a sharp volume decline on a negative development, which takes shape when the price of an underlying asset rediscovers itself by going sideways to higher price action on weaker volume followed by a sharp decline to new lows on strong volume.

Example of a bear flag pattern

Example of a bear flag pattern with the BTC/USD trading pair (source: CoinDesk)

A bear flag pattern is characterized by an initial sharp decline and then a period of consolidation. With most bear flag patterns, the volume increases when the pole is being formed, then remains at its new level. Volume typically does not decline during the consolidation period as downward trends are often a vicious cycle driven by investor fear over falling prices. As such, the volume is upwards as the remaining investors feel compelled to take action.

How Do Bear Flag Patterns Work?

Traders can profit from identifying bearish flag patterns by going short on bearish trends. If the flagpole was formed by a move downwards, it forms a bearish flag. If the support of a bear flag is broken, traders can be more confident that the price will continue to move downwards by the length of the pole.

What does a Bear Flag Pattern look like?

The pattern of a bear flag is made up of parallel lines over the consolidation movement. When these lines converge, they are typically called a bull pennant or bear pennant, depending on the type of flag. Like bull flags, bear flags also turn out to be true most of the time. However, they represent a bit more than a brief lull in a bigger move lower. For a bear flag pattern, technical traders can derive a target by subtracting the flag’s height from the ultimate breakout level. To identify a bear flag pattern, traders can take the following steps:

  1. Find the flag pole that will represent an initial decline, which can either be steep or slowly sloping.
  2. If the asset continues to move in the direction of the consolidation, it’s unlikely that the chart will form a bear flag pattern, as the trend of the flag pole has continued to reverse. If the asset instead moves in the direction of the flag pole, then a bear flag pattern has been identified.
  3. The point where the price movement breaks that of the flag is generally when traders place their orders. The length of the flag pole is typically used to calculate the profit target, though a more conservative strategy is to use the height of the flag pole instead.
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Bull Flag vs. Bear Flag: How To Trade Flag Patterns?

The most important component of any flag pattern trade is the entry. It’s generally advisable to wait for a candle to close beyond the breakout point before creating any orders to avoid being burned by a false signal. Most traders will enter a flag pattern trade on the day after the price has broken beyond the trend line.

Day traders may make their entry just several candles after for shorter-term trades, though this comes at a much higher risk of entering on the basis of a false signal. It’s critical to understand that just because flags are continuation patterns, that doesn’t mean you should enter a trade immediately after you identify one.

How to Trade a Bull Flag Pattern?

When compared with other types of charts, bull flag patterns are relatively easy to trade as a strategy can be derived from the shape of the pattern itself. Every good bull flag pattern trade should be made up of these two elements:

  1. Stop Loss: Most traders use the opposite side of the flag pattern as a stop-loss to protect themselves against the price moving in the other direction. Suppose you have identified a bullish flag pattern for BTC/USDT, if the upper trend line is $43,000 and the lower trend line is $40,000, then you would want to set your stop-loss at some point below $40,000.
  2. Profit Target:The length of the flag pole is typically used to calculate the profit target. Suppose you have identified a bullish flag pattern for BTC/USDT, if there is a $1000 difference and the breakout entry point is $43,000, then the profit target would be calculated as $44,000. It’s key to have a reasonable price target because if you’re too optimistic the price may start to move in reverse before you can claim your profits.

How To Trade a Bear Flag Pattern?

Bear flag patterns work in the same way as bull flag patterns, just in reverse. Every good bear flag pattern trade should be made up of three elements:

  1. Stop Loss: Most traders use the opposite side of the flag pattern as a stop-loss to protect themselves against the price moving in the other direction. Suppose you have identified a bearish flag pattern for BTC/USDT, if the upper trend line is $43,000 and the lower trend line is $40,000, then you would want to set your stop-loss at some point above $43,000.
  2. Profit Target:The length of the flag pole is typically used to calculate the profit target. Suppose you have identified a bearish flag pattern for BTC/USDT, if there is a $1000 difference and the breakout entry point is $43,000, then the profit target would be calculated as $42,000. It’s key to have a reasonable price target because if you’re too optimistic the price may start to move in reverse before you can claim your profits.

Even when the formation of a flag pattern is obvious, there is no guarantee that the price will move in the expected direction. This is especially true of the cryptocurrency market, which is much more volatile and unpredictable than traditional asset markets. As with most technical analysis, you will get the best results from flag patterns by applying them to longer-term charts as you will have more time to consider your strategy and analyze the price action.

Remember that no matter how good you get at reading bull and bear flag patterns, there are times when the trade will just not work out. That being said, a sound and well-executed strategy based on the identification of flag patterns with proper risk management will benefit your portfolio in the long run. If you’re not confident about applying bull and bear flag patterns to real-world trades just yet, Phemex offers a fantastic paper trading platform that you can use to hone your skills.

Bear or Bull Flag vs Pennant

It’s not uncommon to see the term “pennant” whenever there’s mention of flag patterns. Pennants are identical to flags in that they’re characterized by converging lines during a consolidation, after which a large price movement occurs followed by a continuation. The only difference is that the consolidation of a pennant pattern features converging rather than parallel trend lines.

Example of a bear pennant pattern

Example of a bear pennant pattern (source: chartpatterns.com)

Combining Bull and Bear Flags With Other Indicators

On Phemex, you can combine the bull and bear flag patterns with other indicators to help plan out your trades. The best indicators to combine with flag patterns are popular indicators such as the Relative Strength Index (RSI), which can help show if the existing trend is oversold (bullish) or overbought (bearish).

Once you have selected the relevant trade pair, click on the Indicators button at the top of the chart and a new window will pop up. Input RSI in the search bar and you will find the indicator.

Click on the indicator to fill the chart with trend lines. In this example, we are using the daily chart for the RSI indicator. If we switch to any other time on the chart, the indicator will adjust accordingly. Here is what the RSI indicator trend line looks like on the daily ETH/USDT chart:

Combine RSI with Bull or bear flag

Example of an RSI indicator with the ETH/USD trading pair on Phemex

How To Use Flag Patterns With The RSI Indicator?

Let’s use Phemex charts for this demonstration:

  1. Choose a trading pair, such as BTC/USDT, ETH/USDT,or SOL/USDT.
  2. Choose the chart you want. If you’re trading for the long term, choose 1D or 1W charts.
  3. Click on Indicators, find RSI, then click on it to activate it.
  4. Draw a new trend line on the existing lines.
  5. Plan your trading strategy according the identified flag trends.

What Are the Key Differences Between Bull Flag and Bear Flag Patterns?

As two types of flag patterns, bull flag and bear flag merely serve as indicators of trend development and their difference comes down to the following:

  • Downtrend vs uptrend: Bull flag and bear flag are both continuation patterns that form when the price of a stock or asset pulls back from the predominant trend in a parallel channel.
  • Bull flag: A bull flag is a sharp, strong volume rally of an asset or stock that portrays a positive development.
  • Bear flag: A bear flag is a sharp volume decline on a negative development.
  • Bull flag and bear flag share the same traits: Traits of Flag Patterns include support and resistant levels, flag, flag pole, breakout points and price projections.
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Conclusion

While a bull flag validates that the preceding uptrend will continue, the bear flag ensures that the preceding downtrend is likely to occur. Bull flags are sharp rallies followed by a period of consolidation that forecast the breakout of an asset. Bear flags are sharp downturns followed by a period of consolidation that forecast the reversal of an asset. Price patterns such as bull flags and bear flags provide insight into what traders think and feel at a specific price level.

Learning how to identify and use indicators helps grant a greater deal of certainty for both short- and long-term trades, especially when combined with fundamentals and basic technical analysis. Like with all indicators, the identification of a flag pattern does not necessary guarantee that the price will move in any given direction, and it’s best used with other trading signals and indicators for more scientific projections.


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