Capitalizing on Failed Flags and Pennants
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Capitalizing on Failed Flags and Pennants
Flags and pennants are short-term continuation patterns that are commonly used by momentum traders to identify potential entries in a strong trend. A flag is a rectangular pattern that slopes against the primary trend, while a pennant is a small symmetrical triangle. Both patterns represent a brief pause in the trend before it continues in its original direction. However, these patterns can and do fail. This article will teach you how to identify and trade failed flag and pennant patterns.
Understanding Flag and Pennant Patterns
The Flag Pattern
A flag pattern is formed by a sharp, near-vertical price move (the "flagpole"), followed by a period of consolidation in a rectangular channel that slopes against the trend. A bullish flag will have a downward sloping channel, while a bearish flag will have an upward sloping channel.
The Pennant Pattern
A pennant pattern is similar to a flag, but the consolidation period is characterized by a small symmetrical triangle. The flagpole is the same as in a flag pattern.
What is a Failed Flag or Pennant Pattern?
A failed flag or pennant pattern occurs when the price breaks out of the consolidation in the opposite direction of the primary trend. This is a effective reversal signal that indicates that the trend is exhausted and a new trend is beginning in the opposite direction.
Failed Bullish Flag/Pennant
A failed bullish flag or pennant occurs when the price breaks down below the lower trendline of the consolidation channel. This is a bearish signal that indicates that the uptrend has failed and a new downtrend is beginning.
Failed Bearish Flag/Pennant
A failed bearish flag or pennant occurs when the price breaks out above the upper trendline of the consolidation channel. This is a bullish signal that indicates that the downtrend has failed and a new uptrend is beginning.
Strategy: Trading Failed Flags and Pennants
Here is a step-by-step guide to trading the failure of flag and pennant patterns:
- Identify the Flag or Pennant Pattern: Look for a stock that is forming a clear flag or pennant pattern.
- Wait for the Failure: Wait for the price to break out of the consolidation in the opposite direction of the primary trend.
- Entry: For a failed bullish flag/pennant, enter a short position when the price breaks down below the lower trendline of the consolidation. For a failed bearish flag/pennant, enter a long position when the price breaks out above the upper trendline of the consolidation.
- Stop-Loss: For a failed bullish flag/pennant, place your stop-loss just above the high of the consolidation. For a failed bearish flag/pennant, place your stop-loss just below the low of the consolidation.
- Profit Target: Your profit target can be calculated by measuring the length of the flagpole and then subtracting that distance from the breakdown point (for a failed bullish flag/pennant) or adding it to the breakout point (for a failed bearish flag/pennant).
Example Trade: Failed Bullish Flag
Let's say a stock, "High Flyer Inc.," has a sharp rally from $50 to $60 (the flagpole). It then consolidates in a downward-sloping channel between $58 and $56.
| Price Action | Signal |
|---|---|
| Price breaks down below the lower trendline at $56 | Failure |
| Entry | Short at $55.50 |
| Stop-Loss | $58.50 |
| Target | $45.50 ($60 - $50 = $10; $55.50 - $10 = $45.50) |
In this example, the failed bullish flag provided a clear signal to go short. The risk was well-defined, and the potential reward was significant.
Tips for Trading Failed Flags and Pennants
- Volume Confirmation: Look for a surge in volume on the breakout in the opposite direction of the primary trend. This confirms that the failure is genuine.
- RSI Confirmation: Look for a bearish RSI divergence on a failed bullish flag/pennant, or a bullish RSI divergence on a failed bearish flag/pennant.
- Consider the Timeframe: These patterns are most reliable on intraday charts, such as the 15-minute or 60-minute chart.
Conclusion
Failed flag and pennant patterns are effective reversal setups that can lead to substantial profits. By learning to identify and trade these patterns, you can capitalize on the failure of a continuation pattern and turn it into a profitable reversal trade. Remember to always use a stop-loss and to be patient in your trading. With practice, trading failed flags and pennants can become a valuable part of your trading arsenal.