Are you guilty of waiting for a pullback that NEVER comes…only to watch the markets move higher without you?
It sucks, it’s happened to me too many times I lost count.
But the good news is… it’s an easy problem to fix!
By leveraging the power of a specific chart pattern called the bull flag— it’s one of the few reliable patterns you can trust in a bull market.
Here’s what I’ll cover for you today:
- What is a Bull Flag pattern
- How do I enter a trade
- How do I exit a trade
- Where do I set my stop loss
And before you’ll know it, you’ll be adding an additional skill to your trader’s toolbox.
By definition: A bull flag is a continuation chart pattern that signals the market is strong and likely to continue moving higher after a slight period of consolidation.
A bull flag gets its name from it’s two major parts…
- Found in bull markets
- The formation is a type of flag pattern
Let’s break this down further…
1 ) A bull market
A bull market is a word used to describe an upward trend in a financial instrument, such as a stock, FX, commodity, etc.
Essentially, stock prices are rising and in a strong upward trend.
Also, if someone tells you a stock is bullish, they mean that it is a stock that is equal to or stronger than the markets and likely to continue higher into the future.
2 ) What Is a flag and pole
A flag is a chart pattern that resembles a flag on a pole.
The Pole: In finance, as a stock price rises rapidly it creates a vertical pattern that resembles a pole in the ground.
The Flag: As traders take profits, the stock then starts to consolidate and head sideways or slightly downward. This sideways price action resembles a flag.
Putting it together… this resembles a flag and pole standing tall.
And here is the pattern you may see in a stock chart…
So this is how you identify and spot a bull flag while trading.
How to identify a bull flag
- Look for a strong trending move higher. Sideways and downward markets do not signal bull flags.
- After the strong trending move higher is finished, it needs to “breath” and you can spot the flag with sideways consolidating or slightly downward prices.
- During the pullback, watch for smaller ranged candles compared to the higher move in the pole, and watch for a break higher above the upper flag trendline.
Pro tip: Anything more than a “slight” downward price is not a bull flag, but instead a bull trap.
Here’s what I mean:
As you can see, the pole is steep and the consolidation seems normal to the untrained eye. But, the pole is sloppy and has erratic price action and bars that are not bullish enough, and some of the candles are large inside the flag which is a cause for alarm.
The outcome? Well, this turned into a fake breakout with lower prices. The bull flag was “weak” and could not support higher prices causing the pattern to fail and the bears to take control and drive prices lower.
How psychology impacts the bull flag
It’s human nature to be attracted to or desiring things that are: exciting, popular, or something you are not actively involved in.
In a bull flag, everyone wants to take advantage of the trend and buy shares up like crazy driving prices higher than forms the pole pattern.
Once everyone makes their profits the sideways consolidation begins and starts to attract traders who may have missed the first run-up.
During a period of sideways price action, the breakout traders start to take their positions. These are the traders who have been stalking the price action since the run-up of the flagpole and now want to see a breakout to higher prices. These traders start to take positions in the stock at or near the upper flag trendline.
Once enough traders start to buy up stock at these trendlines a breakout will be imminent. As a bull flag trader, it is best to stalk this pattern and place orders at or above the upper trendline to ensure you are involved as the stock heads higher.
Pro tip: Enter the stock slightly above the lower flagpole trendline for the best risk-to-reward trade instead of after the breakout.
The Bull Flag – The Breakout
Here’s the thing…
Most of the time, you can expect a Bull Flag to form after a breakout or during a strong trend.
There are times where Bull Flags are formed when the market is in a range and trading at a resistance level.
Why does this happen?
Well, it is because there are no sellers stepping in to push stock lower or buyers willing to buy at a resistance level.
Either way, this is a sign of potential strength and the markets are looking for a breakout higher.
So how do you trade this safely?
Using a bull flag!
How to identify a breakout signal
- Identify a range market
- Wait for the bull flag to form at or below resistance
- Trade the breakout
- Exit trade at a measured move
Here is an example:
This is a perfect example of the SPY’s.
Let’s break this down…
- There was a bit of consolidation reaching back to 2019 and continuing through the new year and into 2020.
- A bull flag formed lasting over a week in early 2020
- A breakout of the upper resistance occurred signaling the entry of trade
- Exit trade at the measured move price target. Can leave stock on and trail exit if desired.
The Bull Flag – Trend Continuation
Breakout trading, not your style?
Have you ever looked at a chart and thought to yourself:
“This price is just too high! I need to wait for a support level before I go long”
And the next thing you know, the stock just continues higher as you wait and watch.
It sucks sitting on the sidelines and has happened to me plenty of times.
So what’s the lesson? In strong trending markets, it’s much easier to buy breakouts than to wait for pullbacks.
And a bull flag will help signal where to enter these trades!
So, another way to trade the bull flag is to use this pattern as a trend continuation entry signal.
How to identify a trend continuation signal
- Look for a strong trending market.
- Wait for the Bull Flag pattern to form
- Go long on the breakout
Using the hourly time frame, the 100 ema is a great way to gauge the strength of trends.
Remember, strong markets never go back to support…and this is no different.
Since the markets never pulled back to any support levels, if a trader was waiting for a pullback they would have missed over a 5% run in the markets!
Variations to the bull flag
Like everything in life, nothing is “picture perfect” and typically have slight variations in the pattern.
The three major patterns are:
- The Rectangle Pattern
- The Flag Pattern
- The Pennant Pattern
Since every financial instrument is different, the same goes for a bull flag pattern as well!
As you can tell – each pattern is similar but slightly different from one another.
In a horizontal rectangle bull flag, you will see narrow and horizontal support and resistance levels.
This shows uncertainty in the markets and the bulls or bears can’t gain control of the stock to push in any direction.
In a flag pattern bull flag, you will see a narrow and downward sloping channel formed by support and resistance levels.
This shows that more bears are in control and profit-taking is occurring from the traders who were trading the prior price increase.
This is possibly a stronger pattern than a rectangle formation in that you have the bears in control of the stock at this point and are placing stop orders right above the resistance level.
These orders that are placed right above resistance levels are explosive orders that will ignite sending the price higher when combined with bulls buying the stock.
This pattern will tend to have the most “bang” after the breakout and has a greater chance to cause another bull flag to occur after the move higher.
This is a pattern with extreme consolidation occurring after the run higher.
A pennant is formed when both the bulls and bears exit the market instead of fighting for direction like in the prior patterns.
When a pennant is formed and the bulls take control of the stock again, there will be an immediate volume spike right at the breakout level signaling higher prices.
Risk management is a touchy subject as many traders have different views on what exactly this means for them.
It is essential that a trader utilizes proper risk management techniques at all times or risk losing it all.
To make sure to always use hard stops in every trade.
Let’s take a look at an example of where to place a hard stop on a bull flag pattern.
For the SPY bull flag trade:
Entry price : $323.25
Pole Length : $322.60 – $320.50 = $2.10
ATR value : $0.83
Target price (measured move) : $323.25 + $2.10 = $325.35
Lower support of flag : $322.60
Hardstop price : $322.60 – $0.83 = $321.77
In this SPY example, those are the key trade levels a bull flag trader should be aware of for proper risk management on this trade.
So why should you use an ATR as a hard stop offset?
Well, each trade has its own unique movement or volatility every day.
This is determined by using the highs and lows of every bar. One indicator that checks all the boxes is the ATR indicator.
For the hard stop value, it’s key to place it under the lower support of the bull flag to avoid getting “stop hunted” by sudden price action.
This offset will guarantee you will stay in the trade and capture the breakout move you were looking for.
I spend a lot of time reading charts because they tell an extremely detailed story.
These are war stories of those on the battlegrounds as bulls and bears fight to control the stock.
Remember that history does repeat itself!
If you can recognize patterns in a stock that suggests future price action then you can put yourself into a better position to capitalize on stocks.
Today you learned:
- What a Bull Flag pattern is and the differences between them
- How to enter various types of trades
- How to exit a profitable trade using measured moves
- How to have risk management you can count on
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