Bull Flag Pattern
The bull flag pattern is a bullish continuation chart pattern that signals the likely extension of an existing uptrend to higher prices. Its counterpart is the bearish flag pattern that signals the continuation of an existing downtrend. Technical analysis traders use price action patterns such as a bull flag to identify low-risk market entry price levels for day trading, swing trading strategies.
The bullish flag pattern derives its name from its appearance on a price chart, which resembles a flag pole with a flag extending from it, angled slightly downward. Some traders note that the pattern also looks a bit like a capital “F,” angled slightly to the right. It is a pattern of market consolidation that includes a slight countertrend retracement to the downside.
In this article, we’ll cover identifying the bull flag pattern, how to use the pattern in trading, the relative advantages and disadvantages of using the bull flag pattern, and the difference between the bull flag and a closely related chart pattern – a bullish pennant.
How to Identify a Bull Flag Chart Pattern
A bull flag pattern typically appears in an uptrend following a sharp rise price that extends a stock or other financial security to a new near-term high. The bullish flag formation appears when the market experiences a temporary corrective retracement to the downside before resuming the uptrend and moving to new, higher prices.
Several key characteristics can help investors accurately identify a bull flag pattern when it occurs:
- The first characteristic is that the controlling uptrend should have experienced a sharp, rapid increase in price before forming the flag pattern.
- The bull flag is not considered a valid bullish trading signal if it occurs in a market that has been essentially trendless, trading in a small range, or a market that has only been making a very gradual move to the upside.
- The trendline marking the uptrend’s most recent price movement should have a steep angle. The flag pole is a long bar or candlestick – or a series of bars or candlesticks – formed by a trading period that moves price sharply higher and closes at or near its high.
- The second characteristic is the formation of the flag part of the pattern.
- The flag forms as a trading channel sloping downward to the right. This is created by a downside retracement of price from the high reached by the flag pole.
- Then an upside move to a high that falls short of the flag pole high.
- After that, a move down to a price lower than the one of the first downside retracement.
- Another move up, with the high falling short of the previous upside move
- A move down to a lower retracement low – and, finally,
- A move upward where price breaks out of the channel, resuming the existing uptrend and advancing to higher highs beyond the flag pole’s high.
There may be more than just a couple of retracements and recoveries with lower highs and lower lows before a breakout continuing the uptrend occurs.
You can use a stock screener, such as Finviz to help you find bull flags occurring in stocks.
The Bull Flag and Volume
Trading volume is an additional key element in identifying a bull flag pattern. The bull flag is interpreted as a stronger trend continuation signal when its formation includes three specific points of high volume.
- First, the strong move upward in price that forms the flag pole should be accompanied by high volume.
- Second, the retracement lows that occur in the flag part of the pattern should also show increased volume. This indicates that, even though the stock price is falling lower, each new retracement low attracts a large number of buyers that are sufficient to turn price back to the upside.
- Finally, the upside breakout from the flag pattern should feature notably higher volume – this is a further signal that buyers are regaining control of the market.
How to Trade the Bull Flag
The bull flag pattern is one of many trading strategies used by traders either to enter a market on the buy side or as an opportunity to add to existing long positions.
A buy signal is generated by a bull flag when price breaks above the upper trend line of the channel that resembles a flag – the trendline connecting the interim highs formed during the retracement and price consolidation phase that the flag represents. Alternatively, more conservative traders won’t initiate a buy until the pattern is confirmed by the breakout of price above the high price of the flag pole part of the pattern.
However, it’s worth noting that waiting for confirmation of the resumption of the market’s uptrend actually requires traders to take on a higher amount of risk. That’s because the guideline for placing an initial stop-loss order when trading the bull flag pattern is to place your stop-loss a bit below the lowest price of the flag retracement. Thus, entering a buy trade when the price breaks above the top of the flag channel risks less trading capital than entering the market at a new high price above the flag pole high.
The key to successfully (i.e., profitably) trading this pattern is to make sure that, first of all, all the elements of the pattern are present – flag pole, flag, and upside breakout. Secondly, make sure that all the characteristics outlined above regarding the previous uptrend, the price action that occurs during the formation of the flag – a series of lower highs and lower lows, and the pattern of accompanying volume, are also present.
Initial profit targets for a bull flag buy trade are commonly set at a level above the breakout point from the flag channel that represents the distance from the low to the high of the flag pole.
Advantages and Disadvantages
Historical backtesting has shown both the bull and bear flag patterns to be reliable, with success rates of approximately 65%-70%. Thus, it’s been among the most reliable chart patterns for traders to use.
One advantage of the bull flag pattern is that it’s a price correction chart pattern that’s relatively easy to identify visually when it appears.
Additionally, it provides traders with a relatively low-risk market entry point, so even if the pattern turns out to not be valid, a trader isn’t risking a lot of money on the trade.
Many traders look for a stronger trading signal from the flag chart pattern by using additional technical indicators.
For example, the pattern may be considered a stronger trading signal if the flag retracement extends to around one of the Fibonacci retracement levels, such as a 23.6% or 38.2% retracement from the flag pole high. Alternatively, traders may look for the low of the corrective retracement to coincide with a trend line representing a relatively short-term moving average price level, such as a 10- or 20-period moving average.
A disadvantage of trying to trade bull flags is that so many elements are necessary for the pattern to generate a legitimate buy signal. As a result, traders may miss out on a trading opportunity because the pattern lacks one or more key features that define it, but the price breaks out to the upside regardless.
Another disadvantage is simply the disadvantage common to all chart patterns – the possibility of the pattern generating a false trading signal. The price of a stock may appear to make an upside breakout from the flag, thus luring traders to buy, but then reverse to the downside and completely collapse the previously existing uptrend.
The Difference Between a Flag and a Pennant
Bull flags closely resemble another chart pattern – the bullish pennant. Both the flag and pennant patterns are continuation patterns that generate a buy signal following an upside breakout from a downside corrective retracement.
However, the bullish flag pattern can be distinguished from the pennant pattern by the shape formed by the price action that occurs during the downside retracement prior to the breakout and resumption of the uptrend. A bullish flag pattern creates a downward sloping channel formed by a series of lower highs and lower lows. In contrast, a bullish pennant is a retracement pattern that creates a triangular shape that is formed by a series of lower highs and higher lows.
The images below illustrate the difference.
A bull flag is a widely used chart pattern that provides traders with a buy signal indicating the probable resumption of an existing uptrend. Traded properly, it can be among the more reliable technical indicators of a continuation pattern and offer traders a relatively low-risk trade with a favorable risk/reward ratio. The key to successfully trading a bullish flag pattern is to wait for all of the pattern’s necessary elements to appear.