Like a Bull Pattern in a China Shop
Dear Penny Stock Millionaire,
If you’ve been following me for any length of time, you know I love to trade based on patterns.
Stock market patterns often repeat over and over again.
It’s not an exact science, but it’s about as close to predictable as the stock market gets. The bull flag pattern and its variations are one of the most common and reliable.
Will the bull flag setup work 100% of the time? Of course not. But if you know what to look for, and how to gauge your entry and exit points, you can use bull flag trading to increase your chances of success.
As always, I recommend you paper trade this pattern for a while before you trade with a live account.
Here’s everything you need to know about bull flag patterns.
Tomorrow, I’ll show you three flags, what they look like, so you can see them for yourself, add show you how you can start taking advantage of them.
What Are Bull Flag Patterns?
A bull flag is a powerful upward price movement (the flagstaff) followed by a period of consolidation (the flag). This trade setup assumes another breakout after the consolidation period.
The flag that forms during the consolidation period can look like a rectangle or a triangle (a pennant flag). I’ll show you some examples below.
It’s common for the flag to trend downward — against the trend — before the next upward push. However, there are flags with no downward direction. These are called flat top flags.
Bull Flagpole — Long Plays and Short Covers
The psychology behind flag patterns is important. There are a variety of reasons for the consolidation period. You need to understand them to take advantage of the next big price move.
The bull flagpole forms when there’s a big upward movement in price. Typically this happens when there is some sort of catalyst that drives the change. The catalyst might be a press release or earnings release. It’s something that makes trading volume increase and drives big price movements.
Once the upward trend starts, traders taking a long position buy shares and the price continues to rise. At the same time, traders with a short position will often buy to cut their losses.
How the Bull Flag Forms — Profit Takers and More Short Covers
There are two main reasons for consolidation after a big upward move in price. The first is traders with long positions. The second is more short covers.
Traders who opened long positions on the initial breakout sell shares to lock in profits. They went ‘long’ expecting the stock price to rise. They’ve achieved their price goal and are cashing in. But to sell, someone has to buy, right?
Who will buy these now more expensive shares? Short sellers attempting to close their position because they’ve been caught in a short squeeze.
A short requires borrowing shares to sell. Then the trader repays the shares by purchasing at a lower price. But when the stock goes up, like in the bull flagpole, the squeezed short seller purchases shares at a higher price to cut their losses.
Keep in mind this back and forth goes on for a while — hence the consolidation. Also be aware the trading volume tends to drop during the flag or consolidation period as traders buy and sell within a small price range.
As you can see, there’s some psychology at play. Fear, jubilation, ego, and even a bit of greed underpins the pattern.
Your job is to educate yourself so you see what’s happening and understand why — that’s how you take advantage of the pattern.
Differences Between Bull Flag and Bear Flag
In the stock market, the term bull means an upward trend. Bear refers to a downward trend.
The difference between bull flags and bear flags is the prevailing trend and continuation after the flag forms.
Bull flags and bear flags are mirror images of each other on a chart. Bear flags form during a period of consolidation after a precipitous drop. Bear flags come in the same shapes as bull flags — rectangles, pennants, and flat bottom. The most common bear flag pattern has a slight upturn, or pull back.
Benefits of Trading Bull Flag Patterns
No pattern in the stock market is 100% reliable. Any pattern could resolve with false moves. But the bull flag pattern is one of the more reliable and effective trading patterns. When you start analyzing charts you will see this pattern over and over again.
Even though the three bull flag patterns described below look a little different on the charts, they mean the same thing. The psychology is the same. They behave the same way.
The main benefit of trading bull flag patterns is that they can be more reliable. As long as you time your entry points correctly and set a mental stop loss for your trade, you have a greater chance of taking advantage of this pattern.
Will it happen the way you expect every time? No.
Another benefit is that bull flag patterns happen in multiple time frames. What do I mean by that?
If you search for information on how to trade bull flag patterns, you’ll notice there are differing definitions about what is and isn’t a true bull flag. One trader will tell you the flag is only a ‘real flag’ if it forms between five and 20 days. Another may say it takes three weeks.
Some might say it must pull back. Others say it could even be an upward flag or a flag blowing in the wind.
Know this: Every trading teacher skews their definition to fit their trading style so they can sell you their course. My point is, you can find bull flag patterns over different time frames and with different shapes.
You might see a classic bull flag pattern form and resolve within one trading session. Especially in penny stocks — my preferred stocks to trade. You might also see the patterns form over several days. Swing traders often take advantage of a multi-day bull flag patterns.
The Bottom Line
It’s possible to use this pattern regardless of your trading style, but be aware of the other factors involved in the price movement.
Just because you see a huge price jump followed by a period of consolidation doesn’t mean it’s definitely going to spike again.
This is why I suggest you wait until the new breakout is clear. Be patient.
Once the new breakout is confirmed, then you can make your play. Some people tell me I’m leaving money on the table getting in and out of trades conservatively.
But I’ve learned those ego lessons the hard way.
I focus on a limited number of patterns. Tomorrow I’ll show you charts and show you exactly what the three bull flag patterns look like and how I think you can use them to your advantage.
Editor, Penny Stock Millionaires