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During the incredible rally in gold futures and in the SPDR Gold Trust (GLD), there have been a number of flag formations. Some have lasted many months; others, only a few weeks. This daily chart covers the action in GLD from August through December 2007.

• GLD has just rallied from a low of $63.47 in August to a high of $83.64 in November, a 31.7% gain
• In just seven days, GLD dropped to a low of $76.11 (a 9% decline). This decline signaled that a correction was underway
• Most traders, after missing a sharp rally, are too eager to get back in and buy on the first bounce
• GLD managed to move back above the $82 level before the rally fizzled. This established the downtrend, line a
• On the next decline, GLD held above prior lows, which was a positive sign, and a level of support was established, line b
• The flag formation (line a and b) was not complete until prices reached the apex of the flag-but the rally was still quite dramatic. GLD gained another 20% in the next four months

One of the most historic bear markets developed after the December 1989 high of 38,957 for the Nikkei-225 Index. As I mentioned earlier, flag formations come in all sizes, and after declining for just ten days the Nikkei started to rebound.

• The rebound lasted about three weeks (see red box), and formed a very-short-term flag formation. On an hourly chart, this would be much more evident.
• The Nikkei dropped 10,000 points in the next 33 days, and finally stabilized in April with a low of 27,251.
• The Nikkei began a very sharp rebound, which after a few weeks allowed one to draw the uptrend, line d, which stayed intact until early June.
• Often times you will discover that one flag formation becomes part of a larger flag formation.
• From the May-June highs, you were able to identify a good level of resistance, line c. Thus you had a flag formation, lines c and d.
• The drop through support at line d completed the flag formation. After the initial decline, the Nikkei began to rebound again, and a new level of support (line e) was evident.
• This was part of a larger flag formation, lines c and e. The rally into July peaked at 33,177, which was just below the May high of 33,244
• The completion of the flag had even more negative implications, and the Nikkei lost 12,000 points by September.

How to Profit: By looking for the formation of flags in either up or down trending markets, I think you will be better able to identify good risk/reward entry points.

In this week's Trading Lesson, to be released Thursday afternoon, I'll continue this discussion of flag formations. I'll also show you how Fibonacci analysis can help you identify entries, exits, and protective stops when trading flag formations.

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