I’ve read a few option books.
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Saturday, December 15, 2007

BEARISH FLAG PATTERN – Part 2: Important Characteristics

Go back to Part 1: Bearish Flag Formation.

Important Characteristics of Bearish Flag Pattern

Shape of Bearish Flag:
1) Flagpole:
For Bearish Flag pattern to be more reliable, there should be a very sharp / steep price decrease (almost vertical, and may contain gaps) on heavy volume that makes the “Flagpole” part of the pattern.
Without a steep price decrease, the pattern might be less reliable and riskier.

2) Flag:
A Flag part of the pattern is formed when the price movement is contained within two parallel lines, representing a brief consolidation after the sharp decline.
This consolidation forms a small rectangle that frequently slopes against the preceding trend (i.e. the trend of the Flagpole part).
Therefore, in case of Bearish Flag, since the preceding trend is down, the rectangle flag often slightly slopes upward, although it could be horizontal as well.

Volume should be heavy during the formation of the Flagpole part, then decreasing during the formation of the Flag part, and the volume should spike when the price break down through the support of the lower parallel line of the Flag.
High volume during the breakout increases the chances of continuation of the preceding trend.
Without a volume spike on the breakout, the pattern might be less reliable.

During the formation of the Flag, if the volume remains constant or was even increasing, then the reliability of this pattern would be doubtful and might signal a trend reversal instead.

The duration of the pattern depends on the price fluctuation during consolidation.
The greater the fluctuation, the longer a pattern will take to form.

On a daily chart, this pattern might take about 1 to 12 weeks to develop.
Ideally, this pattern should form between 1 and 4 weeks.

When the duration is between 4 and 12 weeks, the pattern might carry more risk. After 4 weeks, interest in the stock might have decreased and make it unlikely to continue in a strong downtrend.

When the duration is more than 12 weeks, it would be classified as a Rectangle pattern.

Breakout Direction:
For Bearish Flag pattern, the breakout should happen to the downside (i.e. breakout through the lower parallel line).
However, in some rare cases, the price might break against the previous trend, and create a reverse of trend. This reversal pattern may be signaled during the Flag formation by a significant increase in volume, instead of decreasing.

Potential Price Target:
1) Compute the height of the Flagpole.
The height of the Flagpole is the distance from the start (highest point) of the sharp price decrease to the end (lowest point) of the decrease. (See picture in Part 1).
2) Calculate the potential price target:
Subtract the result from the top the Flag to get the Potential Price Target.

Return to Breakout Level:
After the breakout occurs, the price may sometimes return to breakout level for an immediate test of this resistance level. (Remember, the previous support level has now become resistance level).
However, if the price closes above this resistance level, the pattern could be considered invalid.

To read about other chart patterns, go to: Learning Charts Patterns.

Related Posts:
* FREE Trading Educational Resources You Should Not Miss
* Learning Candlestick Charts
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks


Tony Chai said...

Hi OTB :

Thanks for sharing yet more technical analysis patterns.

Wishing You & Everyone a Very Merry Christmas!!

Yours Truly,

Tony Chai
My Options Trading Blog

Tony Chai said...

Hi OTB :

I've just completed an e-book "How To Avoid The 5 Silly Options Trading Mistakes I've Made" where you could download from my blog by just leaving a name & e-mail address.

In the e-book, I've highlighted your blog as a good source where options trading beginner would find useful information about options trading. So don't be surprised if your blog has more traffic coming your way :)

Anyway, Have a Merry Christmas and Happy New Year!!

Warmest Regards,

Tony Chai
My Options Trading Blog

Tony Chai said...

Hi OTB :

Wishing you a Prosperous 2008 with options trading!!

Yours Truly,

Tony Chai
My Options Trading Blog


Hi Tony,

Thanks a lot!
Hope you had a wonderful Christmas too!
And also wish you a very happy and prosperous new year.

Wow, congrats for the completion of the e-book! Well done! :)
I believe it'll be very valuable for many of us, particularly options trading newbies.

And thanks a million for mentioning my blog in your e-book as well.

Good luck to you! :)

Best Regards,
Options Trading Beginner

Tony Chai said...

Hi OTB :

Don't mention it.

You're doing a great job compiling informative stuff (not only on options trading) for fellow traders in your blog.

Good Luck To You Too.

Yours Truly,

Tony Chai
My Options Trading Blog