Sep 25 2023
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Flag Pattern in Forex Trading
By Stjepan Kalinic , Updated on: Apr 07 2023.
A flag pattern is a candlestick formation that forms after a sharp move, followed by a rectangular consolidation that looks like a flag on the pole. This pattern is relatively reliable, with straightforward guidance for taking profit and stop-loss levels.
While hindsight is 20/20, those who are patient and don’t FOMO often get another opportunity. Such is the situation with a flag pattern, a popular forex trading pattern that signals the continuation of the underlying trend even after the big move has already occurred.
What is a Flag Pattern?
A flag pattern is a price action pattern. By type, it is a continuation pattern which means you trade it in the direction of the trend.
The flag consists of 2 parts: the pole and the flag. After an initial burst, the pole forms as the price rises or falls almost parabolically. This is often a news-driven event. Then, in a period of consolidation, the range-bound price action forms the body of the flag – thus giving this pattern the name.
Flags are great for beginners because of 3 factors:
- Easy to identify: Flags are easy to spot due to the parabolic price movement. You will spot them early enough once you know what to look for.
- Reliable: Flags often rank among the best chart patterns, with a success rate of over 66%.
- Give entry and exit targets: Trading systems should always avoid ambiguity. Flags give price targets, entry and stop-loss levels. Arguably, trendline drawing is the only weakness, but it is not difficult to learn.
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How to identify a flag pattern?
Since the flag is a continuation pattern, you must first know whether you are in a trend or consolidation. A bullish trend will have clear higher highs and higher lows, while a bearish one will have the opposite - lower lows and lower highs. Avoid trading this pattern in the ranging market.
As always, keep track of the higher time frames for confirmation. High timeframes like 4-hour or daily can help you gauge the current state of the market quickly. Using a 50 or 200-period moving average might help as well.
To spot the flag, look for bursts in price, usually characterized by a few to several candles which are above average in size and all of the same color. A consolidation caused by the initial profit-taking will follow, usually 5-20 candlesticks at the most. This consolidation will represent the rectangular body of the flag. Research has shown that tighter consolidations generally perform better.
Bullish Flag Forex Example
Consider the following example of a GBP/USD long setup based on the bullish flag. First of all, you might notice that the trend is bullish as we have a clear trend of higher highs and higher lows.
Eventually, there is a strong bullish push upwards, as the price rises over 50 pips and makes a new high. A tight consolidation follows this in the form of the flag.
GBP/USD 15 min chart with a flag pattern, Source: TradingView
The long trade occurs once the upper trendline breaks. Eventually, the price rises by another 50 pips, hitting our take profit.
Bearish Flag Forex Example
There is more than one flag in the following example, but not every setup is valid. The first flag on the left has a smaller pole, occurring in the ranging market. However, the second flag comes with the steeper pole and appears in an established downtrend — there is a clear sign of lower highs and lower lows.
EUR / USD 15-min chart with a bearish flag pattern, Source: TradingView
Once the flag breaks, the price quickly goes to our take profit levels, offering a minor opportunity to enter on the pullback.
Notice how the flag breaks on the former support level that now turned into resistance!
How to trade flag patterns?
You can find flag patterns on all time frames. One of the big advantages of this pattern is that it forms after sharp rallies or steep declines. These substantial moves tend to stick out on charts.
When you identify the flag, pay attention to two things: the height of the pole and flag trendlines. This requires a keen eye and precision because these levels will dictate the entry, stop-loss, and take profit targets.
A general rule is to measure the height of the pole and add it to the breakout point of the flag as a take-profit projection. Meanwhile, the stop-loss level will be on the other side of the flag, just beyond the last data point that the price reached.
Here are the numbers for the 2 examples from above:
GBP / USD long
- Height of the pole: approx. 50 pips
- Projected profit target: 1.36700
- Stop Loss: 10 pips (1.36100)
- Risk-Reward ratio: 5:1
EUR / USD short
- Height of the pole: approx. 30 pips
- Projected profit target: 1.13670
- Stop loss: 8 pips (1.46070)
- Risk-Reward ratio: 3.75:1
Flag and Pennant differences
Pennants are similar to flags, except for one difference. In the pennant formation, trendlines are converging instead of running parallel. Instead of a rectangle, they form a small triangle as the price gets more compressed.
A good sign of a promising pennant is when volume dries up as the pennant forms and then increases upon the breakout. A general rule of thumb for any breakout in trading is that the volume confirms it.
Flag pattern risks
Like everything in trading, chart patterns have their probabilities. No chart pattern works all the time, as in the market, anything can happen.
According to elaborate research by Samurai Trading Academy, bull flags are about 67.13% reliable, while bear flags are slightly better at 67.72%.
Furthermore, Thomas Bulkowski (author of the “Encyclopedia of Chart Patterns”) noted that tight flags perform better than loose flags — meaning that the consolidation inside the pattern looks more compressed. However, Mr.Bulkowski studied the stock markets, which have a traditional upwards skew as stocks tend to rise over time. On the other hand, the forex market is neutral as it trades as a ratio.
Yet, when it comes to entry positioning, traders are divided between aggressive and conservative approaches. The aggressive approach suggests entering on the break of the trendline of the flag, while the conservative approach looks to enter only after the price breaks through the highest (or the lowest) point of the formation.
Conclusion
Flags have been the favorite pattern for many market technicians and traders over the decades. First of all, they are easy to spot, and second — they are reliable enough to produce consistent results.
However, searching for them can be time-consuming, and they require drawing trendlines which can be subjective.
Overall, flags rank high on our list of favorite chart patterns, and if you’re patient enough to trade them, you might find your profit & loss statement deeply in the green.
Frequently Asked Questions
How many candles are in a flag pattern?
On average, the flag pattern contains between 5 and 20 candlesticks. They can be in a tighter or a looser formation, but generally, you should prefer higher and tighter flags as they are more reliable.
Is the flag pattern bullish or bearish?
Flag patterns can be either bullish or bearish. The bullish flag will have a sharp upward movement, followed by the declining consolidation, while the bearish flag will feature a sharp drop — followed by the rising consolidation.
How do you use flag patterns in forex?
You trade the flag breakout in the direction of the trend. Pay attention to 3 things: the height of the formation as a measure for the profit target, the thickness of the flag for stop-loss placement, and volume confirmation for the breakout.
