Technical analysis allows for the study of a variety of different trading patterns to assist traders timing their entries and exits. One of the most useful patterns in a trending market environment is used to spot continuations in price. Today we will look at identifying and trading the bear flag pattern in an established down trend.
Identifying the Pattern
Identifying a bear flag can be easy once you know what you’re looking for. The pattern itself is divided into three parts. First we need to find the flag pole which will be identified as our initial decline. This decline can be steep or slowly sloping and will establish the basis for our trend. Next we have the flag itself. This is identified as a period of consolidation after the completion of prices initial decline. During this period, prices may slowly channel upward and retrace a portion of the initial move. At this point traders will wait for price to break to lower lows in the direction of the trend.
After price begins to move lower again, we can then find the final component needed for trading a bearish flag pattern. The profit target is a potential value to take profit after a currency pair’s next decline in price. This pricing level can be identified by first measuring the distance in pips of our initial decline. This value can then be subtracted from the peak resistance line formed from our consolidating flag. Now that we know what we are looking for, let’s look at an example in today’s market.
EURJPY showing the bearish flag pattern
Above we can begin to see the potential of a bearish flag pattern being created on the EURJPY daily chart. The flag pole has been established by connecting the June 21st high at 101.61 with the July 24th low at 94.10. Totaling the difference between these points culminates in an initial decline of 751 pips. Currently price is in the consolidation phase of the pattern. As price gradually rises, we can see the flag pattern take shape. It’s important to note that we won’t be sure that we have an established bearish flag pattern until price breaks out to lower lows. At that point, we can use our 751 pip initial decline to establish potential price targets near 91.00.
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Bearish Flag pattern (FAQs)
How do I know where to enter the trade with the bearish flag pattern?
The flag will trade upwards in a channel but the move to the downside is often revealed with successive lower highs and lower lows. Traders take note of Fibonacci levels, which are mathematically significant ratios that occur in nature and are often observed in financial markets. These levels are depicted using the fibonacci retracement indicator and can assist traders in identifying entry levels where the "flag" could turn and continue in the current trend.
Bearish flag pattern or start of a bullish breakout?
Some traders fall into the trap of mistaking a bearish flag pattern for a bullish breakout. Bearish flag patterns tend to be gradual rises in price in a downward trend whereas breakouts often exhibit sharper moves to the upside. There are indicators to assist traders in spotting potential breakouts with one of these being the Donchian channel.