Trading Flags and Pennants | FXTRADING.com - International

Trading Flags and Pennants

Admin, October 29th, 2020

Flags and pennants are continuation patterns which appeal to technical traders due to their relatively high frequency. Whilst they occur more frequently on intraday timeframes, they can also appear on daily, weekly and monthly charts. But the best way to seek such patterns is to find a strong directional move on a higher timeframe, then flick through a lower timeframe to seek these popular continuation patterns.

Here we can see that the DAX 30 (DE30) endured there particularly bearish days (left chart). Over this same period, two bearish flags formed on the hourly chart. By drilling down to even lower timeframes, it is likely a trader could have found more flags or pennants.

 

Flags vs Pennants:

The main difference between a flag and a pennant is the duration they take to form, and the slope or angle of the patterns. They are both ‘short-term’ patterns that generally last between a few or more bars and can be seen as a pause or consolidation within a trending move. And, as they are both continuations patterns, they are expected to breakout of their consolidation phases in the same direction that momentum entered it.

Flags:

  • Flags are characterised by a gently sloping channel which retraces against the trend.
  • A bullish flag appears within an uptrend and its retracement slopes slightly downwards within two parallel channels
  • A bearish flag appears within a downtrend and slopes slightly upwards within a rising channel.

Pennants:

  • Pennants are similar to flags, except their trendlines converge into a small triangle and are generally shorter (in terms of depth and duration) than flags.
  • A bullish pennant appears in an uptrend and is essentially a small consolidation (or pause) within a strong trend.
  • A bearish pennant appears in a downtrend.

 

Measured moves:

It is generally accepted that flags and pennants appear around the centre of a move. For this reason, an approximate target can be generated by measuring the initial move into the pattern and projecting it from the pattern itself. It is not an exact science, but their accuracy can appear relatively decent compared other traditional chart patterns.

However, at times is not always straight forward to know where to measure the flag from. The trader should not simply measure the entire move from the prior swing point. Instead they should identify the strong part of a move which precedes the pattern. If you think of it as the ‘mast’ of a flag, it becomes easier to identify.

Moreover, the characteristics of flag’s mast can provide a decent indication as to how the breakout from the flag should appear, as its trajectory should be similar. Therefor the quality of the breakout from these patterns can be used to filter higher probability patterns.

In this example, there was a clean, directional move lower into the flag pattern. This provided an indication that we should expect a strong move to exit the pattern. Also note that the flag did appear around the centre of the move.

In this example it, had a trader measured from an obvious swing low to the flag, their upside target would have been unnaturally high. Yet the ‘strong’ part of the move began without printing a prominent swing low, so this would have been a more sensible place to measure from. Using the stronger section of the trend provided a much more accurate target. Of course, they do not always work out this week.

 

Methods to Enter a Trade with a Flag or Pennant

Once a strong move and pattern is detected, we would not expect the flag or pennant to retrace too far against the strong trend. Under such a scenario, a trader could confirm the flag or pennant once prices have broken beyond the recent high (in an uptrend) or low (in a downtrend).

Whilst traders often place protective stops behind the pattern, a more aggressive approach would be to place it behind the chosen breakout level. After all, a strong initial move expects a strong breakout.

In the following example we show how an evolving pennant could be analysed and potentially entered for a short signal.

  1. The S&P 500 (US500) was trading within a strong downtrend, and a pennant pattern was forming near recent lows. The trader wanted to project a price objective but there was some ambiguity as to where they measure the flag from.
  2. Given the overlapping candles between 3389.94 – 3409.65 (yellow congestion zone) the trader could have decided to use the high of the H1 bar which initially broke out of the yellow congestion zone to measure the pennant’s target.
  3. Projecting the move from the pennant’s current high (3375.57) suggests the target is around 3345.38.
  4. However, beneath the pennant is a key support level from a bullish pinbar at 3364.48. The trader decides they will wait for a break beneath 3364.48 support before entering a breakout of the pennant.

At this point, the trader could have created a sell-stop order beneath 3364.48 support to enter short trade with a bearish breakout. With this approach, the trader would not have to be near their computer to enter the trade, which is useful for EOD traders or anyone who cannot spend much time trading at their computer.

Alternatively, the trader could have setup a price alert with a break beneath key support and enter a short order, live at market.

Patterns Can Morph Before Confirmation (Yet Still Work Out)
However, as we can see the pennant did not initially work as anticipated. Instead, prices retraced slightly higher and formed a bearish flag before breaking out. The approaches outlines above still apply and the target remains the same.

Interestingly, the trader who setup a sell-stop order would have been none the wiser the pattern had morphed, as their short position would have still triggered under the assumption that a pennant had formed. Yet a trader who was monitoring in real-time could have invalidated the pennant when prices broke higher.

However, the 2-bar reversal formed an hour later could have alerted the trader to a potential swing high and bearish flag pattern.

Prices eventually broke beneath 3364.48 to confirm the flag and hit target an hour later. Take note that momentum exiting the pattern almost perfectly matched momentum leading into it, making it a textbook example.

A Breakout from a Flag or a Pennant Should Be Seen with Conviction
Whilst there are no hard and fast rules as to when a pennant should breakout, the range should be relatively small compared with the preceding move, whilst the breakout should occur after a few bars and close firmly beyond the pattern.

In this example, GBP/AUD was trading within a strong downtrend and formed a bearish flag. However, the flag was quite choppy which made picking an entry level harder and its measured move was short relative to the size of the flag. These were key warning signs that this that the flag may be a lower probability trade.

Whilst prices did break lower, momentum lacked conviction and the candles had wide upper and lower wicks to show bears were not truly in control. At this point the trader could tell that subsequent price action since the breakout did not fit with the spirit of a bear flag. They could have then trailed their stop quite tightly to minimise risk or decide to close the trade with a small profit.

Interestingly, prices eventually made it close to target, but it made very hard work of it. Ultimately, this is not a very good flag and signs were present when it broke out.

Entering a Break of a Trendline
If a flag produces a deeper correction against the dominant trend, they are still tradable patterns. Although under this scenario a trader may want to enter a break of pattern’s trendline instead of waiting for a break of a cycle high (uptrend) or cycle low (downtrend). If entering using a trendline, the trader would be wise to make sure the potential reward to risk ratio is adequate to enter, assuming prices stall at the next high or low.

In this example are two flags on the Nikkei 225 (JP225). Bull flag #1 provided a relatively wide oscillation but, otherwise, traded within a well-defined channel. Had we looked at the daily chart over the same period, the flag formation was easier to identify.

Flag #1:

  • A trader could have considered entering long when H4 closed above the upper trendline.
  • Bullish momentum picked up which initially appeared promising, and then reached the initial target near the most recent high.
  • However, the trader should have been alert to a potential failed pattern once a bearish hammer formed, then began to retrace within another flag formation.

Flag #2:

  • As the new flag formed, the trader of flag #1 could have questioned whether it will reach target as price action is no longer traded with a similar trajectory to the prior leg higher. They could either tighten their stop to protect profits or close their trade.
  • However, they could also consider entering long on the break of the trendline of flag #2.
  • On this occasion, prices turned aggressively lower just after the trade was entered and likely stopped the trader out. Moreover, it may have also stopped out the trader of flag #1 if they had not raised their stops.

 

This example raises questions as to whether the trader should enter a break of the trendline or break of the cycle high or low. Ultimately, we do not have a crystal ball to see if trades will work in advance, and both methods can work or fail.

But traders can do the following to help reduce unnecessary drawdowns:

  1. Use risk management to minimise the negative impact of losing traders.
  2. Monitor price action closely once a pattern is confirmed to see if price action fits with their expectation of flags or pennant breakout. Ultimately, these are strong continuation patterns so any signs of hesitancy early on should send a clear warning that the pattern may fail.

Leave a Reply

Your email address will not be published. Required fields are marked *

*

*

*

Straight to your inbox

Get The Latest Market News & Forex Trading Tips Delivered.

Join a growing list of like-minded traders and get the latest market information, tactics, and news right in your inbox.

Subscribe

Ready To Start Trading On FXTRADING.com ?

Open Live Account or Get 30-Day Free Trial

Send this to a friend