Forex Flag Pattern Trading Strategy
The flag pattern is one of the most popular chart patterns. The main reason for that is how simple it is to spot the flag pattern on the chart. Most chart patterns become easy to spot after the fact, while the flag pattern gets detected way before the completion.
In this article, I will explain to you how to trade the flag pattern step by step. Below is a list of what will be covered:
- What is a flag pattern
- Flag pattern identification guidelines
- How to measure target
- Where to place the stop-loss
- How to enter
What is a flag pattern?
There are two different flag patterns bullish and bearish flag patterns. To keep this article as short as possible, I am going to explain how to trade the bullish flag pattern. For the bearish flag pattern, you’ll do the opposite direction.
Flags are trend continuation patterns. You expect the breakout to be in the direction of the significant prevailing trend. They are a complex correction or pullback.
Flag pattern identification guidelines
A bullish flag pattern is formed when you see a bullish impulsive leg, followed by a downsloping rectangle bounded by two parallel trend lines. For best results, the rectangle should form by at least two swing highs and two swing lows. Tall and wide flag performs better than short and narrow flags. The correction move should not be steep; corrections that have a slope between 0-45 degrees are the best performers.
Flag pattern example
In the chart below, we have two Bullish flags that formed after each other. Each one started by a significant bullish impulse, followed by a complex correction bounded between two trendlines forming the downsloping rectangle. This is the most common behavior, a fast-moving bullish price action, followed by a complex correction that forms the flag.
Flag Pattern Identification Characteristics
- Steep, quick price trend forms the pole
- Price action bounded by two parallel trend lines. Prices
usually, go against the prevailing trend
- The slope of the flag has a slope between 0-45 degrees
Different types of flag patterns
In the example below, you can see a different kind of flag pattern. This is also a valid pattern, while it is not as common as the flags with the downsloping rectangles. The strong bullish impulse is evident, while the correction was not sloping down. This time the price went sideways in a range instead. A flag with a long-range usually has a sharp momentum break out and often reaches target fast.
The pennant flag pattern
The pennant is also a flag pattern, the pole rules are the same, a robust bullish leg, but instead of a downsloping rectangle, the price swings form a triangle either downsloping or symmetrical. Pennants are more common than the flags with a sideways range. A pennant is also traded as a Triangle as well. But be careful when trading pennants and Triangles, you will see many fakeouts. As I am writing this article, I did also publish my Weekly Trade Ideas video on my YouTube channel. There was a great example of a pennant/Triangle that formed on AUDUSD, and I explained in detail how a fakeout may happen and where it may reverse again. Here is the link for that Weekly Trade Ideas video, it will start where I was explaining the trade idea. The main take here is not to trade all the patterns just cause they formed, be picky, and with time and much practicing, you may also start predicting possible fakeouts like that one.
Don’t wait for the perfect patterns only
As you see in the chart below, three flag patterns in a row weren’t “Textbook patterns.” The market is never perfect, and if you would only trade the patterns that you see in textbooks, you’ll miss many great opportunities. These defected flag patterns are my favorite ones. All of them had made a trapping move before they broke the trendline, which is a sound signal that the market may continue lower. When I see these traps happening ahead of the real break of the trendline, I get very interested and feel much more comfortable taking the trade than trading the textbook pattern. The most crucial level here is the lower trendline, and when it is broken, then the signal to sell is done.
Like all chart patterns, flags are not immune to failure. So is there a way to avoid pattern failure? Yes, there is a way that I will cover later, but even that will not prevent you totally from a losing trade or entering a pattern that may fail. In the chart below, you can see how the flag formed following the same identification guidelines mentioned above. In this case, a bearish flag, the pole had a robust bearish impulse forming the pole of the flag, followed by the rectangular correction. But, in this case, there was no trend continuation, price broke the correction rectangle to the upside instead of a trend continuation lower.
Flag patterns trading tactics
There are many ways to trade the flag patterns. Today I will cover the most common techniques and how I trade the flag pattern. The textbook strategy is straightforward, but I like to add some confluence when taking trades. No matter if I am looking at a candlestick pattern or a chart pattern, I want always to see at least one confluence to enter a trade. In the examples below, I will explain more in detail how I use confluence to enter a flag pattern trade.
Measuring the target or the exit point when trading the flag pattern is pretty simple. You measure the length of the pole and then project it from the location of the flag breakout. In the chart below, you have an example of how to measure your target. There should be no confusion during the planning of the target here. It is a pretty straightforward process. When trading the right flag pattern, it should be effortless to measure the target.
Here you have another example, this time we have a bearish flag pattern. The measuring rule is the same. You measure the length of the pole, and you make a projection of that from the breakout point of the flag.
Flag pattern entry and exit strategies
There are many ways to plan and trade the flag pattern. I will start with the most common entry and target planning. When trading flags or any pattern, it is essential that you find the right pattern. To be sure of the pattern you are looking at, make sure that you use the identification guidelines mentioned above. Consult the chart below as I review it.
So, how to enter a flag pattern trade?
The textbook entry of the flag pattern is to place a trade as soon as you have a break and close outside of the flag channel. So if it is a daily chart, you enter the trade when there is a daily candle close above the channel upper trendline. The same would be if you were trading a flag that formed on the 1H time frame; you enter after a 1H candle close above the flag channel.
Like all other patterns, the higher the time frame, the stronger is the signal. But all the rules are the same, both for entry, targets, and stop-loss placement.
For targets, as explained earlier, the textbook target for the flag pattern trading is to measure the pole and project it from the breakout point. While as you see in the example below, I am using another technique. When there is a significant swing high as below, I try to take half profit at that significant swing high. It is an area of resistance, and we can never be sure that the price will break higher. After closing half the position, I then move my Stop-loss to breakeven and wait for the price to either reach the full target or my stop-loss.
Where to put the Stop-loss?
For the stop-loss (SL) placement, I use the ATR indicator to calculate the stop-loss level. The main rule is to place your SL below the low of the flag channel. But you also have to add some buffer, so you don’t get stopped out on a short term spike in the price. That’s when you need to check the ATR indicator and add that value as the buffer below the low of the channel. So if you are trading out of the daily chart, you look for the ATR value during your entry. Let’s say the ATR is showing 50 pips, and then you put your SL 50 pips below the low of the flag. You do the same if you are trading out f the 1H chart, but this time we look at the 1H ATR value to use as buffer below the low of the flag.
How to trade flag pattern before the breakout
Wow, could that be possible? Well, yes, it is. Most textbooks tutoring on how to trade patterns teach you very late entries. I don’t like that, despite the case of a better confirmation. To me, it feels like I am chasing the price when entering after a breakout. So when not spice it up a little and get a much better entry and way better risk to reward.
Now, wait a moment, and don’t get too excited. Just because I am going to show you how I like to trade the flag pattern, does not mean it is the best and only way. Keep in mind, the example above is what you should be doing if you want a more safe approach.
Flag pattern trading á la Pierre
There is one flag pattern that I like to enter before the breakout. For me to take such a trade, I want to see something similar to the example below. Consider the chart below, and you’ll see a significant bullish impulse The bullish move, broke above two major swing highs, making the idea to go long on the retest an easy decision.
Trade rules, the price must make a significant surge; in this case, a bullish impulse. The price must break above a significant swing high, signaling a bullish strength and control. When the price starts the correction and forming the flag, I draw a Fibonacci retracement. What I want to see is that the 61,8 Fibonacci retracement is at the previous swing high. I also use the RSI indicator, and the RSI must reach the oversold area before the price reaches the 61,8. Also, if RSI makes a bullish divergence, that is a big plus but not a must. If those rules got met, I either place an order just above 61,8, or open trade at market depends if I can be on screens and watching the charts or not.
Since the price does a deep correction to the 61,8 Fib retracement, we can put the Stop-Loss below the low of the pole and still have an excellent risk to reward. Trading the flag this way need much discipline, and you have to wait till the rules got met. Also, this pattern does not appear as much as a regular flag pattern that usually corrects between 38,2-50%.
Trading the flag pattern with other confluences
Below we have another example where you could trade the flag pattern ahead of the breakout. The first rule of a significant impulse is there. The price broke two key swing highs as well. The correction started after that break above the tops. When the price reaches the previously broken structure and at that same level, the 200 Moving Average (MA), we got a pin bar (Hammer). That hammer is a reversal candlestick pattern, and since it happened at the key structure level and the 200 MA, that is my trigger candle. But for more confirmation, I wait for another candle to close above the high of the hammer. If the next candle closes above the top of the hammer, then I enter a long trade at the open of the next candle.
For stop-loss, I use the same rule, which is at least 1 ATR below the low of the hammer in this case. Target one is the high of the flag’s pole and the second target at the next significant swing high or at least a 1:2 risk to reward.
When not to trade the flag pattern
Many times you hear traders saying that to have the right winning rate, you must trade each pattern you see and that met your rules. I kind of understand why mainly cause when you do your backtesting, you do count all the patterns, both the failed ones and the winners. But again, trading a flag pattern that forms just below a key resistance area is not a good idea. In those cases, better to wait for the break out to happen first and then look for a new flag pattern to go long.
In the chart below, we see a clear resistance area looking left. The price did form a bullish flag and broke out of the flag channel. But as soon as the price reached the resistance area, the price reversed down in a fast bearish move. So it is a good idea to have a rule not to trade the flag patterns that form just below key resistance areas.
I hope that you found this article helpful and that you got a better understanding of how to trade the flag pattern. Keep in mind to trade these patterns in the direction of the prevailing major trend for the best performance. Also, keep in mind that market structure is a very important aspect of trading any chart pattern. In my PA-FX Trading Course and Mentoring Program, I do a whole session about market structure. To me, the structure is always first and everything else comes after. So when I mention an indicator that is only to be used as the confluence with structure and not to be traded on its own.
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