Technical Classroom: How to use classic chart patterns in trading

Continuing with the classic chart patterns, we will be discussing about flag pattern. A flag pattern is a trend continuation pattern named after its visual similarity to a flag on a flagpole.

It is composed of a strong price move that forms the flagpole, followed by an orderly and diagonally symmetrical pullback, which forms the flag. When the trend line resistance on the flag breaks, it triggers the next leg of the trend move and the stock proceeds ahead.

The main feature of the flag from a typical breakout or breakdown is the pole formation representing almost a vertical and parabolic initial price move. There are two types of Flag patterns. They are a Bullish Flag or Bearish Flag.

A Bullish Flag pattern starts with a strong almost vertical price spike that takes the short-sellers completely off-guard as they cover in frenzy as more buyers come in off the fence. Eventually, the price peaks and forms an orderly pullback where the highs and lows are literally parallel to each other, forming a tilted rectangle.

The upper and lower trend line are plotted to reflect the parallel diagonal nature. The breakout forms when the upper resistance trend line breaks again as prices surge back towards the high of the formation and explodes through to trigger another breakout and uptrend move. The sharper the spike on the flagpole the more powerful the bull flag is formed.

The bear flag is an upside down version of the bull flat. It has the same structure as the bull flag but inverted. The flagpole forms on an almost vertical panic price drop as the bulls get blindsided by the sellers, then a bounce that has parallel upper and lower trend lines, which form the flag.

When the lower trend line breaks, it triggers panic sellers as the downtrend resumes another leg down. Just like the bull flag, the severity of the drop on the flagpole determines how strong the bear flag can be.

The author is derivative & technical analyst at Motilal Oswal Securities