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Flags are one of the most used price patterns in technical analysis, and one of the most frequent price pattern. They are continuation patterns, and thus allow traders to identify continuation phases. Flags are period of soft price correction following a strong price movement, whether upwards or downwards. After the initial movement, the price is expected to bounce between two parallel lines, which form the flag. Since the flag is a continuation pattern, the price is supposed to breakout from these two lines in the same direction than the initial movement, upwards or downwards. Thus, a bullish flag is a flag aiming downwards after an initial increase of the price of the commodity. A bearish flag is a flag aiming upwards after an initial decrease of the price of the commodity.

What does a flag look like?

Like pennants, the initial movement of the flag is called a flagpole. The flag is materialized by two paralel lines, the support (the lower yellow line) and the resistance (the higher yellow line), in-between which the price bounces. The price may exit the flag in a movement that follows the flagpole. This phase is called the breakout. The breakout level is the price mark at which the price breaks out from the flag. During the flagpole phase, the exchanged volume is generally high. Lower volumes should be expected while the price remains whithin the flag. The breakout from the support or the resistance is accompanied by high volumes.

How to trade the flag price pattern?

As stated above, flags are continuation patterns. As such, the price is expected to breakout from the flag in the same direction as the flagpole. Traders shall anticipate the breakout. Thus, it is necessary to carefully watch out during the flag phase for a sudden increase in volume as the price approaches the support or the resistance line. If the breakout from the flag is confirmed, one might expect the asset to gain or lose at least half of the value it gained or lost during the initial movement. On the picture above, the flag is bullish, since the flagpole is aiming up. For instance, let’s consider that the price of the asset flew from 5 to 5.5 USDT (a 10% increase), before stabilizing around 5.3 USDT, and that the breakout level was 5.4 USDT. We could then enter a long position and take profit at around 5.7 USDT which would be rougly a 5 % increase from the breakout level – half of the increase during the flagpole. A stop loss could be set at the lowest point of the flag. If the price were to drop below that limit, that would invalidate the continuation pattern, and signal the start of a bearish trend.

Combining flags with technical analysis indicators

As usual, it is best to trade with several indicators or patterns at once to make more accurate predictions. One could imagine confirming the flag with the MFI indicator to both watch for increasing volume and oversold/overbought signals. On the picture above, the MFI, which combines volume and price trend would rise during the flagpole phase and reach over the 70 mark, moderate during the flag phase and stabilize between 40 and 50, and reach high levels again at the the breakout. A bearish flag would see the MFI reach particularly low levels during the descending flagpole phase – below 30 -, consolidate around intermediary levels during the flag phase, and reach low levels agains at the breakout.