How to Spot and Trade a Bear Flag Chart Pattern
10/15/2009 12:01 am EST
The morning session, continuing over from a pattern into yesterday’s close, gave us an excellent example of a bear flag that I’d like to show you as an educational reference on trading tactics and enhanced flags. Let’s take a look:
We’re seeing a TradeStation chart of the five-minute SPY along with the 3/10 Oscillator and the TICK.
I must say this flag took me a bit by surprise thanks to the final push up into yesterday’s close, but that also serves as a reference of real world trading.
The flag began with an initial impulse lower (pole) into the 1:30pm CST lows of Monday. Impulses are impossible to predict in advance.
Then, a 45-degree angular retracement formed, which allowed for the drawing of two trend lines (as shown) as price retraced back to the confluence of the 20- and 50-period EMAs, setting up the flag portion and triggering the trade entry for the pattern.
The ideal entry occurred just after the shooting star candle at 2:35pm CST as price had retraced upwards into the 61.8% Fibonacci retracement and the 50-period EMA. Both expected to serve as overhead resistance if this indeed played out as a bear flag.
A stop loss would be a minimum of ten cents (1 @ES point) above the 61.8% retracement, which often serves as the line in the sand between the maximum retracement of a successful versus an unsuccessful flag pattern. Aggressive traders might have even decided to place their stop above $108, which was the price high of the pole.
As for the target, I like to take a 100% Fibonacci price extension/projection from the top of the flag to project a minimum objective. In this case, the minimum objective was $107.03, which as you see, was quickly exceeded.
The next target might be a 138.2% Fibonacci extension of the impulse (instead of 100%, which would be a perfect measured move of the impulse, a 138.2% extension is more in line with how the Fibonacci extension tool is used), which came in at $106.76. The absolute low of the day—and of the pattern—was $106.75. Impressive!
Many traders like to exit positions at such targets and consider “flipping and reversing,” meaning to buy on any bounce off of a price target, which is an aggressive strategy.
The one caveat to note about this bull flag was the final swing up into yesterday’s close, which was a red herring and may have led to some premature stop losses being triggered for those who entered short expecting a bear flag to play out. Otherwise, strict daytraders would have exited on the close. Only swing traders who endured the pullback into the close could have taken full advantage of this bear flag.
An alternate way to anticipate the trade, or at least play off the price target, was to see the flag into yesterday’s close and note the downward action of the morning session and then short to play for the $107.03 price target. In other words, expect the structure of the flag to carry down and drive price down to the expected target.
I’ll likely try to work this flag in as an enhanced flag example in my presentation “Best Trades to Take Using Momentum and TICK” at the Las Vegas 2009 Trader’s Expo (register now!).
The more you see these patterns, the better you’ll be able to recognize and trade them effectively when they appear in real time.
By Corey Rosenbloom of AfraidToTrade.com