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Monday, December 10, 2007

BULLISH FLAG PATTERN – Part 2: Important Characteristics

Go back to Part 1: Bullish Flag Formation.

Important Characteristics of Bullish Flag Pattern

Shape of Bullish Flag:
1) Flagpole:
For Bullish Flag pattern to be more reliable, there should be a very sharp / steep price increase (almost vertical, and may contain gaps) on heavy volume that makes the “Flagpole” part of the pattern.
Without a steep price increase, 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 increase.
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 Bullish Flag, since the preceding trend is up, the rectangle flag often slightly slopes downward.
However, the Flag 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 out through the resistance of the upper 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 uptrend.

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

Breakout Direction:
For Bullish Flag pattern, the breakout should happen to the upside (i.e. breakout through the upper 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 (lowest point) of the sharp price increase to the end (highest point) of the increase. (See picture in Part 1).
2) Add the result to the bottom 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 support level. (Remember, the previous resistance level has now become support level).
However, if the price closes below this support level, the pattern could be considered invalid.

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

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