[candlesticks] A Simple but Powerful Chart Pattern?

[TheNegotiator 13]

For all the different methods of technical analysis employed to place a trade and all the different forces within markets nowadays, do simple patterns still have a place in your repertoire of trades? Well, I would personally say that the answer to this question is a categorical yes with the one qualifier that the pattern must be a strong indication of the underlying auction and the inventories being added to or squared up.

 

One such formation that I really like(given that I have done well from it in the past) but probably under utilise is the Flag Formation and in my next post, I'll discuss the ins and out of trading it.

[TheNegotiator 13]

So the basic premise of a flag formation is that there is a fairly clear directional move(flagpole), then consolidation(flag) and finally a break which is in the order of magnitude as the flagpole. A flag is a continuation pattern which can be either up or down(inverse flag if you like). The thing that you really need to be looking for is a less volatile consolidation phase(flag) on lower volume than the original move(flagpole). The reason for this is that say there is a good deal of buying on the move up for example. The conditions for continuation are going to be shorting in the consolidation against the stronger buyer, hence the lower or weaker activity. On a break of the consolidation, the sellers will generally liquidate, adding to the secondary push higher. If this selling is stronger then you'll likely not see a consolidation at all, but an immediate reversal.

 

See the attached image for an example in the NQ.

[TheNegotiator 13]

Finally, you might ask what I was talking about in the example in the previous post when I mentioned that the break of the consolidation needs to hold. Well duh! Of course it needs to hold! The reason this is of particular interest is again one of inventory. Failed flags can and do happen. I would personally would not jump straight back in on a stop out to reverse into a failed formation, but you certainly could look at doing that I'm sure. The failed flag is in a bull flag example, initial strong buying followed by weaker selling and consolidation. The break then occurs on more buyers and capitulation of sellers. However, then stronger selling does enter the market and reverse the initial strong buying.

 

I personally have had most success with flags on a 3-10min chart as I think that the inventory on these timeframes work well with this formation intraday. Not to say it wouldn't work elsewhere. The last thing I forgot to mention is about entry. I enter on a break with increasing activity and expect to have the continuation progress within a few bars. Just one more thing (in a non-columbo kinda way), if there is a clear flag consolidation pattern and it goes on for a good while without showing signs of breaking, my expectation is of a complete reversal.

 

I hope you enjoyed this cursory look at flag patterns and feel free to discuss or correct me!!