Technical analysis of price patterns can tell you a lot about potential market movements. Some signals, like the flag and pole pattern, can indicate either bullish or bearish trends depending on how they occur. To make a smart trading decision, you must interpret the signals accurately.
In this article, we delve into the meaning and features of the flag and pole pattern, the different types of this pattern, and how you can trade this indicator smartly.
What is the flag and pole pattern?
Flag and Pole Pattern is a chart pattern identified in technical analysis that signifies a potential continuation of an existing trend. It emerges after a sharp price movement in either direction (the pole), followed by a period of consolidation within a defined range (the flag). Once the price breaks out of this range in the same direction as the initial movement, it often resumes its previous trend.
Technical analysts identify the flag and pole pattern as a continuation signal. This pattern emerges when a security's price experiences a sharp movement (the pole), followed by a period of consolidation within a defined price range (the flag). A breakout from this range, typically in the direction of the initial price move, suggests a potential continuation of the underlying trend.
The indicator is called the flag and pole pattern because it resembles a flag and a pole. The original sharp price movement makes up the pole, while the range over which the price consolidates resembles a flag.
The defining features of the flag and pole pattern
Since the depiction of a flag and pole pattern can be quite vague for beginners, it is essential to be aware of the features that define this pattern. This way, you reduce the risk of misinterpreting or missing this pattern on the price chart. A flag and pole pattern typically has four key elements:
- The preceding trend:
This is the sharp and sudden price movement that occurs before the consolidation phase. Also known as the prior trend, it can be upward or downward depending on the type of flag and pole pattern that is being formed. - The consolidation:
Here, the price abruptly changes direction and continues to consolidate in that direction — within defined support and resistance levels. If the range is quite narrow, you may easily miss the formation of the flag and pole pattern. - The breakout:
After consolidating over a few trading sessions, the price then breaks out from the consolidation range. This breakout occurs in the same direction as the prior trend (and in the opposite direction of the consolidation range).
Additional read: What are Intraday Trading Indicators
Specifications of the flag and pole pattern
The flag and pole pattern is characterized by four key components:
- Preceding trend: An initial, sharp price movement in a specific direction, which serves as the "pole" of the formation.
- Consolidation phase: A subsequent period of price consolidation within a defined range, resembling a "flag."
- Volume profile: A distinct volume pattern characterized by an initial surge, followed by a decline during the consolidation phase, and a renewed increase as the price breaks out.
- Breakout: A decisive move beyond the consolidation range in the direction of the preceding trend. A price target equal to the length of the pole is often projected following this breakout.
Types of flag and pole patterns
Flag and pole patterns can be bullish or bearish, depending on the direction of the prior trend, the consolidation, and the breakout. Here is how you can identify the type of flag and pole pattern you are looking at on a chart.
- Bullish flag pattern
The bullish flag pattern is characterised by an initial upward price movement, followed by a consolidation phase resembling a flag. The price typically appreciates during the initial trend before entering a period of sideways trading. A breakout above the flag's resistance level presents a potential entry point. Profit targets can be set equal to the length of the preceding upward movement (flagpole). A stop-loss order should be placed below the flag's support level. While increased trading volume often accompanies a breakout, it is not a prerequisite. Nevertheless, heightened volume can serve as a confirming indicator of growing investor interest. - Bearish flag pattern
A bearish flag pattern is characterised by an initial downward price movement followed by a consolidation phase. The price declines during the initial trend before entering a period of sideways trading. A breakdown below the flag's support level signals a potential entry opportunity for short positions. Profit targets can be set equal to the length of the preceding downward movement (flagpole). A stop-loss order should be placed above the flag's resistance level. Unlike the bullish counterpart, trading volume tends to diminish during the consolidation phase of a bearish flag pattern. This often reflects the prevailing sentiment of fear and uncertainty among investors as the asset's price declines.
Technical analysis of the flag and pole pattern
To understand how to trade the flag and pole pattern effectively, you must first have clarity on what these price movements technically mean. The prior trend is sharp and abrupt, indicating a sudden domination of any one trader group (sellers in the case of a bearish pattern and buyers in the case of a bullish one).
The consolidation range is weaker but often slightly longer, indicating that the opposite group is trying to regain control. However, if and when the price breaks out of the flag and pole pattern and continues in the direction of the prior trend, it means the original group that was responsible for the initial sharp move has gained control once more.
The stronger they are, the more likely the trend will continue in the direction of the breakout. To check the strength of the trend, assess the volume during the prior trend, consolidation, and breakout. It should typically be high during the prior trend and the breakout but lower during the consolidation phase.
How to plan your trades based on the flag and pole pattern?
Trading a flag and pole pattern requires clarity about the price directions, price strength, and momentum. To establish the price direction, you only need to look for visual confirmation. To check the strength of the price movement, evaluate the volume, Relative Strength Index (RSI), Average Directional Index (ADX), and On-Balance Volume (OBV), among others.
Then, here is how you can set your entry, exit, and stop-loss points.
1. Trade entry
To avoid misinterpreting a flag and pole pattern as some other indicator (or vice versa), wait for the price breakout. If you are entering a long position, time your trade for the day after the price shoots past the consolidation range. If you are shorting, you must enter the market the day after the price falls below the support level of the consolidation range.
2. Target profits
Your target profit depends on your risk tolerance. If you have a conservative outlook, your profit margin should typically be the price difference between the support and resistance values of the consolidation phase. If you can take on more risk, you can also add the price range of the flag’s pole to your profit margin.
For instance, consider the following scenario. The price of a stock shoots up from Rs. 100 to Rs. 107. Then, it dips slightly and consolidates from Rs. 107 to Rs. 105. Thereafter, the price breaks out upward past Rs. 105.
Here, the price differential in the consolidation range is Rs. 2 (i.e. Rs. 107 — Rs. 105). The flag pole’s price range is Rs. 7 (i.e. Rs. 107 — Rs. 100).
So, the target exit point (or target profit) for a conservative investor would be Rs. 107 (i.e. Rs. 2 past the breakout price). The target exit for a more aggressive investor would be Rs. 112 (i.e. Rs. 7 past the breakout price).
3. Stop-loss limits
The stop-loss is typically placed at the bottom of the flag (or the support level) in a bullish flag and pole pattern and at the top of the flag (or the resistance level) in resistance level) in a bearish pattern.
Conclusion
Technical analysis offers valuable insights into potential market movements. The flag and pole pattern, for instance, can signal trend continuation. However, accurate interpretation is crucial for informed trading decisions. This article explored the flag and pole pattern's characteristics, different types, and its technical implications. We also discussed how to leverage this pattern for strategic trade planning, including entry, exit, and stop-loss points.
Remember, effective flag and pole pattern trading requires a combination of visual confirmation, volume analysis, and other technical indicators. By mastering this pattern and practicing sound trading discipline, you can enhance your ability to navigate market trends.
