How Three Flags and a Candle Can Make you Money
Before you can trade using any of the 3 bull flag patterns we discussed yesterday, you need to understand how to read a candle.
Candlestick charts were developed in 18th century Japan by a rice trader. They’re called candles because they look like a candle with a wick on both ends.
The main part of the candle — the body — represents the closing and opening prices for a given period. The ‘wick’ lines — called shadows in trading — represent the highest and lowest prices during the period.
Bullish candle formations are traditionally white or unfilled. These days you often see them as green on charts. Bullish candle formations signify the closing price was higher than the opening price.
Bearish candle formations signify the closing price was lower than the opening price. Bearish candles were traditionally black or filled-in. Modern charts often show them as red. Check out the graphic below for the basic idea.
One final consideration before we take a look at the patterns: You should know your entry and exit points before you make a trade based on these patterns. For that matter, you should keep a trading journal of every trade. I do — and I teach all my students to do the same.
1. The Flat Top Breakout Pattern
This is an awesome bull flag setup. In this pattern, there’s no pullback and no downward slope during the consolidation period. Instead, the consolidation has a flat top. The stock trades sideways as the flag forms.
Then, after the period of consolidation, the upward trend continues. Once the new breakout begins, it’s a good idea to wait for confirmation. It’s also a good idea to have a price target for getting out of your position.
The chart below is a great example of why you should wait for confirmation of the new breakout. Notice I’ve drawn an extra line there in the flag area. There are a few trading periods where the price broke through and then dropped back below that orange/brown line.
In other words, the top of the flag was tested for breakthrough but it didn’t happen. In this case, it happened several minutes later. While it makes for a slightly messy chart — not the ‘perfect’ flag — it’s a perfect example of why you need to be patient.
Example of The Flat Top Breakout Pattern
SVCL chart showing flat top breakout by FreeStockCharts.com
There are varying opinions about the right exit point and I couldn’t cover every aspect of that in this email. But I will say this: know your exit point.
When the stock price reaches your pre-determined exit point, close your position.
Be happy with the small wins as you grow your trading skills!
Here’s one common formula: Take the price range of the first flagpole and add that to the price at the bottom of the flag. That gives you the new target price. As you look back at the chart above, notice the breakout is roughly the same height as the flagpole.
I haven’t used exact numbers for the above example. I want you to learn how to see it on the chart. But when you write down your trade setup you should have an exact entry and exit pre-determined.
Oh, and don’t go chasing the trade!
If you miss your entry point because things are moving too fast, sit this one out.
Don’t let your ego get the best of you if the stock is running up past your exit price. Develop self-discipline.
“But Tim,” you say, “what if I sell and the stock keeps going up beyond my exit point?”
… First, be happy with small gains and take the win.
… Second, it’s going to happen. You can never perfectly predict the peak of a gain every time. It’s always better to play it safe, than risk your investment because of your ego.
2. The Descending Flag Pattern
This is the classic bullish flag pattern and the one you’ll see the most. In this pattern, the consolidation period is a pullback so the flag descends. If you look at the LOCO chart below, you can see several pullbacks as the stock moves up.
In this example, the flag forms over a period of consolidation lasting several days.
Example of The Descending Flag Pattern
Descending Bull Flag. by FreeStockCharts.com
3. The Pennant Flag Pole
A bull pennant forms as the trading range narrows during the consolidation period. The result is a triangle shaped flag. The classic pennant shape appears to slope down from the top and up from the bottom. Occasionally you’ll see pennants with a flat top or flat bottom.
Check out the FRLF chart below. It’s not perfect but you get the idea. The consolidation happens over several days and the trading range narrows along the way. It’s interesting to note that when you look at this in different time frames the pennant is not as obvious.
Example of The Pennant Flag Pole
FRLF chart showing Pennant Flag. by FreeStockCharts.com
Key Tips to Find and Trade Bull Flag Patterns
Learning to recognize a bull flag pattern on a chart is a skill you develop over time. The most important thing you could do today is look at some charts. If you don’t have a trading platform yet, try looking on a website like Yahoo Finance or BigCharts.
- Look for stocks with a surge in price related to high trading volume and a news catalyst …
- Then look for the period of consolidation …
- Finally, look for the price breakout above the consolidation along with increased trading volume.
Also, try different time frames when you look at the chart. Sometimes the bull flag is clear when looking at a 12-month daily chart. Other times it’s obvious when you look at a single day with five-minute candles.
If you’re serious about bull flag trading…
And I think you should be…
Use a trading platform with a bull flag pattern screener. It will look for all the right conditions based on news, trading volume, and price movements.
Bull Flag Pattern Technical Analysis Skills
You’ve heard me say it before: This isn’t an exact science.
Even in the examples above you can see there are variations. The key things to understand are the initial upward movement, the consolidation period, and the breakout.
Now go look for this pattern on some charts! By looking for them you’ll start to notice how it works.
The only way to get better at identifying them is do it. Look at the charts, pick out the flags, paper trade, and see if you can correctly find them. Once you start being consistently profitable, then you start to trade with real money.
Only Trade Easy and Clear Patterns
One of the reasons I like bull flag patterns is because it’s clear and it’s easy. The psychology is fairly straightforward and you can set your entry and exit points based on what you see on the chart. You can set your mental stop loss easily.
I recommend you keep it simple at first. As you develop knowledge and skill, trading clear and easy patterns can become second nature. That’s what you’re going for.
The Bottom Line
The bull flag pattern is like a gift that keeps on giving.
The bottom line? Human nature hasn’t changed a whole lot over the centuries. We have the same needs, wants and desires as our ancestors.
The bull flag pattern is built around human psychology.
It’s not magic.
It’s based on actions and reactions of traders.
Once you see and understand the bull flag pattern, you can take advantage of it because human nature drives it.
Editor, Penny Stock Millionaires