Guide to Flag Pattern Trading in Forex


Flag Pattern Trading is a common and famous forex technical analysis tool that helps the trader to find a possible price direction. In this article, we will see a guideline to trade flag patterns in forex trading. 

25 November 2019 | AtoZ Markets – Spotting Flag patterns is a popular strategy among traders of all levels. It is one of the easiest patterns to spot. However, this pattern is famous for trading continuation price actions. Most of the price action traders believe that this strategy has a good winning ration. Moreover, some price action traders use this pattern along with the other strategies to increase the probability. In this article, we will discuss the details of the flag pattern trading strategy along with an example.

What are Chart Patterns?

In technical analysis, chart patterns are price formations which are represented graphically. The price pattern is recognized by the price movement that is identified using a series of trend lines and curves.

When a price pattern signals a trend change, it is called a reversal pattern, while the continuation pattern happens when the trend continues in the same direction. Technical analysts use the price patterns to examine the current price movements with future market forecasts. This is one of the handiest tools for technical analysts when performing the analysis. Chart patterns are a very common way to trade any type of financial instrument.

The most profitable chart pattern gives the graphic representation of the supply and demand forces. They also display the relative strength of the definite price levels. BAT Pattern in the forex market is one of the profitable chart patterns.

How Do Chart Patterns Work?

The candlesticks have the changeable open, high, low and close. This indicates the trader to confirm the position or enter a new trade. On the other hand, the chart pattern is the set of trend lines uses for predicting the price, which is more reliable than traditional indicators. The chart pattern helps to increase the reliability of the price action by increasing the probabilities of directions towards bullish or bearish.

There are bullish and bearish chart patterns. What makes them justify the trend to reoccur over time, with the possibility of backtesting to find their probability of success rate. There are several profitable chart patterns that are very useful for price action traders. Some of the most profitable chart patterns include:

  •         BAT Pattern
  •         Price Channel Pattern
  •         Symmetrical Triangle
  •         BAT Pattern
  •         Double Bottom Chart pattern 
  •         Rectangle Chart Pattern
  •         Reversal Chart Patterns

From the above mentions patterns, we will discuss the Flag Pattern trading in this article.

What is the Forex Flag Pattern?

The flag pattern is one of the famous continuation formations in forex trading. This pattern works as a consolidation between the impulsive legs of a trend. When this pattern appears on the chart, there is a high likelihood that the price will continue towards the direction of the prevailing trend. Before proceeding to the trading entries, let’s get familiar with the structure of the Flag pattern.

Flag Pattern Structure

The Flag pattern consists of two parts – The Flag & the Flag Pole. The flag is actually a pattern that looks like a flag of any country. On the other hand, FlagPole is the price direction outside the pattern. Let’s have a look in detail- 

  • The Flag Pole

After the formation of a flag pattern, there will be an impulsive move, which is referred to as the FlagPole. After that, a brief consolidation will start that will be named as the Flag.

The FlagPole is the primary and significant component of a Flag pattern. The flagpole is the beginning and the ending part of a flag that represents an impulsive momentum. In the Flag pattern, we will trade the impulse after a correction. Therefore, it is important to identify the key profit-making portion of the pattern. 

  • The Flag

After creating the pole, a valid Flag pattern will begin within a tight range. The shape of the range will like a flag. There will be a distributed top & Bottom in the flag. In this manner, the beginning and the ending part of the flag pattern is the flag pole.

Take a look at this image below, as an example:

Flag Pattern Trading

How to Trade Flag Pattern:

As mentioned above, the Flag Pattern works as a continuation price action on the chart. Therefore, a valid flag pattern is likely to push the price towards the direction of the FlagPole.

Taking Entry in Flag Pattern

Traders should attain a confirmation signal before taking an entry in the flag patterns. However, the confirmation of the Flag pattern trading comes with a breakout.

If you want to trade a bullish flag, you will buy when the price closes a candle above the upper side of the flag. On the other hand, if you have a bearish flag, then you would sell the pair when you see a closing candle below the lower part of the pattern.

Setting Stop Loss in Flag Pattern Trading

After you open your trade, you should set your stop-loss order. Setting a stop loss is a crucial part of the forex trading to protect your trade from unexpected price moves.

  • One basic rule is to set up the stop loss is- close the trade as soon as the price moves above or below the opposite of the flag because the pattern is most likely false. 
  • However, the most logical location to place the stop loss is the extreme swing within the Flag structure. Therefore, if you were trading a bullish flag, then your stop should be below the lowest bottom in the Flag Pattern. On the other hand, for bearish Flag, your stop should be placed above the highest peak in the Flag.

 

Setting Take Profit in Flag Pattern Trading

Traders can set two take profit targets for flag pattern trading. The first one is 100% of the flag range and the second one is 200% of the flag range.

However, you should consider the important support & resistance levels to measure the possible take profit level. Moreover, you should take profits at each target level to reduce risk and book profits. Of course, each trader has their own trade management style. Therefore, there is no ultimate guide for setting stop losses. The trader should find suitable measurement of the price action to set their own profit. Moreover, Understanding the market context will help traders to determine the time of an early exit and extend the take profit level. 

Example of a Bullish Flag Pattern Trading:

Here we will see a bullish flag pattern trading ideas with proper trade management. However, the same rules apply to the bearish flag patterns. 

After opening the trade using the flag pattern, put a stop loss below the extreme point of the bullish Flag. When the price increases and reaches 100% of the Flag, you can close 50% of your position size and book some profits. Moreover, you would put your stop-loss order by raising the trading entry-level to minimize the risk. Then if the price continues to increase and reaches your second target level, you can book your complete profit.

However, if your trade management allows, you can extend the 2nd profit target depending on the market context. In that case, you should monitor the price action to confirm the possible momentum.

Flag Pattern Trading: Final Word and Cautions

Flags are created by a sharp price move with a consolidation. You should be careful that the trading breakout can be in the opposite direction. Therefore, like other trading methods, you need to have strong trade management skills. However, if we summarize the overall trading strategy we can come up with some steps:

  1. Identify the current market trend and find a flag pole to confirm the trend.
  2. For buy trade the bullish flag pattern & for sell trade the bearish flag pattern.
  3. Enter the trade when the price breaks the flag and closes the candle.
  4. set stop loss at the opposite edge of the flag.
  5. Set take profit on the 100% and 200% of the consolidation range of the flag
  6. Manage the trade according to the appropriate money management guidelines.

The main problem of the flag pattern trading is a false breakout. However, you can consider the false breakout as another trading strategy. This strategy is signaled based on a breakout. However, the main risk is the price may move quickly in the opposite direction, resulting in a loss. 

In that case, consider cutting losses quickly is a wise idea. This method will help you to keep the loss minimized and gives you time for a new trade. 

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