So-called bull or bear flag patterns that form on stock or stock index charts, suggest a consolidation before a further push in the same direction as the trend immediately preceding the formation of the 'flag'. Flags are useful in trading since they project a further rally or decline.

Before I get into the topic de jour, there was this following stock-specific question that came in to me.

MY E-MAILBAG:

"I believe that you were an investor early on (low price) of Ford (F) in the turn around of the company. F seems to have seen it's high and is getting a bit tired. What do you think about F now?"

MY RESPONSE:

I did mention Ford back when it was trading at $2-3 or so as an example of a low risk situation relative to what I thought would be its upside potential (reward). The stock went from a low of a buck (1.01), rallied then dropped back to 1.5. From there the stock rallied to the $19 area for a tremendous gain. Who could ask for more than that!?.

As you say, the stock looks 'tired', somewhat like the overall market, and Ford stock has been losing (upside) momentum as demonstrated by the recent break below its 200-day moving average. The 'c' down leg of an a-b-c (down-up-down) correction tends to be at least equal to the first downswing. The first downside price gap was a 'breakaway' type gap suggesting substantial further downside. The most recent chart gap could be a 'measuring' gap, suggesting that the move was only about half completed, giving a potential downside objective to around 13.

For my past Trader's Corner article on the trading/trend significance of chart gaps you may click on the following LINK.

E-MAILBAG QUESTION:

"... anything in the recent rally suggest to you that the market has recovered and is heading back up?"

RESPONSE:

In terms of the hourly charts there are so-called bull flag patterns that formed recently that at least suggests further short-term upside potential.

There is also the fact that the S&P and the Nasdaq Composite have rebounded back above their 50-day moving averages and have also climbed back into their uptrend channels. These last two technical aspects I'll cover in my weekend Index Wrap.

The concept of 'flag' patterns and what they can suggest about the future trend are something I'd like to cover in this (Trader's Corner) column. You actually don't see the flag pattern all that much in stocks, at least on daily charts. They are very common in the commodities charts. Still, like many chart patterns, when they do form, a flag pattern suggests a further move (up or down) in the direction of the most recent trend. The projected next move may only be of a relatively short duration, although sometimes the pattern is part and parcel of a prolonged further advance or decline; there are BEAR 'flags' too.

Recent flag patterns (as of 5/27) are highlighted in the following charts, with explanations to follow:






CONTINUATION PATTERNS:

The word continuation comes of course from the verb 'to continue' and in technical analysis terms, continuation patterns are a type of 'consolidation' of the prior movement within the dominant price trend. After an initial strong move up or down, there is typically a countertrend or sideways price movement before the trend renews itself and continues in the same direction as before the consolidation.

After buying interest or selling interest has been satisfied, some participants with stock profits exit part or all their positions. Hence the idea of 'profit-taking' that the financial press likes to say is something that goes on all the time. We wish there were as many profits taken as they say there are!

The investors and traders on the losing side, who bought high and sold low so to speak, are trying to also help themselves; in their case, it's to reduce their losses. In a decline, those long have decided to get out if they can sell on a rally at a higher price than recent lows and will use future rallies to exit. In an advancing trend, those short will use price pullbacks or dips to exit or cover their short positions.

This back and forth movement, after the initial strong surge of a trend, is what creates a consolidation pattern. The common types of consolidations are flags, triangles and rectangles. In this article on continuation patterns, I will focus on bulls and bear FLAG formations.

FLAG PATTERNS :

'Flag' patterns, are part of continuation patterns and are considered bullish in an uptrend and bearish in a downtrend. Flags, and a variety of flag called a pennant. There's an example of a pennant shaped flag pattern in my third chart above of ExxonMobil (XOM). I find it easier to label them all such formations as 'flags'. Flags are relatively short-term sideways consolidations that form during and after prior strong trends.

The duration of a flag in terms of the number of trading periods; (i.e., the number of bars or candles) is typically 3-6 bars, up to perhaps 20. This could be 3-6 or more hours, days or weeks.

A flag pattern's outline is formed by a series of relatively narrow price swings AFTER a sharp, but relatively short, price spurt that's a more or less straight up or straight down move. The initial sharp advance or decline resembles a 'flagpole'. The subsequent consolidation occurs near the top or bottom of the initial price spurt. The narrow price ranges forming the flag have tops and bottoms that allow drawing trendlines across the highs and lows. The two resulting trendlines will usually, not always, slope in the OPPOSITE direction from the initial move.

Examples are seen in the following charts. With technical or classical chart analysis a picture is worth a 1000 words.

A flag formation composed of two sloping trendlines set rather close together, will generally slope against or opposite to the dominant trend. Slope is not relevant to the pennant variation as it makes a triangular shape.

In an uptrend the slope of a flag will be down and in a downtrend, the slope of the flag will be up. Generally, when the price thrust creating the 'flagpole' is up, the subsequent flag slopes down this is a bull flag. When the thrust is downward and the subsequent flag formation slopes up, the pattern is a bear flag.

When a market is in a rapid price move and forms a series of flags, one after the other, there may not be a well-defined preceding 'pole' pattern as can be seen below. (This next chart is of a company no longer listed as "SEBL" since Oracle Corp. bought Siebel in 2005 and its now just one of their brands.)

There is a 'measurement' implication for a further move after an initial breakout. This rule of thumb is for a minimum upside or downside objective, after a bull or bear flag forms, that's equal to the height of the flagpole added or subtracted to the breakout point per my next charts. (eSpeed is the electronic trading network of privately held Cantor Fitzgerald.)

Another example is provided by the Nasdaq 100 tracking stock (QQQ). At first it seemed that the upside objective implied by the bull flag would NOT be met.

I find that the measuring implication for a flag price objective to be pretty accurate usually and flag patterns are a favorite find of mine when I run across them. Especially when I'm in time to take a position ahead of the implied further move.

The stop out or exit point on a trade, if the flag pattern fails to have follow through in the expected way, is to just above/below the breakout point. A series of sell signals were provided by the series of flag patterns seen on my next chart.

The measuring implication for the flag pattern is really a variation of the measured move concept, the idea of a next price swing being at least equal to the prior move. This 'measurement' is a MINIMUM projected objective only; of course the subsequent move is often greater than any minimum projected objective. Nevertheless, having a minimum is valuable in order to establish some parameters as to trade potential.

A flag that forms near either extreme in a trading range will usually be significant. If a bull flag forms at the top end of recent price swing, it suggests there may be enough new buying coming in to kick off a second up leg. The reverse would be true at the low end of a trading range; a bear flag there would suggest that another secondary downswing could be starting.


GOOD TRADING SUCCESS!