What is a Bear Flag Pattern?
The bear flag gets its name from the resemblance between a flag (the upper shadow) which starts on the left side of a hill and ends on the right. As with all chart patterns, there needs to be a confirmation before entering any trade. Typically, I like to wait for a stock to break out of both sets of flags (upper & lower).
Once broken out, I like to see immediate follow-through as well as strong volume support that is confirmed by higher highs/lower lows.The bear flag pattern is a short-term technical trading pattern that uses the two outermost price bars (sometimes also referred to as candles) to form an upper shadow (or flagpole ) and a lower shadow.
The shadows delineate the downward movement of prices, with the body of the first candle projecting above the highs of three previous candles and the body of the second candle projecting below its low.
When a third candle forms in between the two outermost ones, it breaks through both shadows/flags in what is commonly referred to as a breakout or breakdown back into its original trend.
It's important to note that this break signals a reversal and not necessarily an end of a move given that reversals can retrace for short distances before continuing in the same direction.
This retracement is usually referred to as a "consolidation" and can last from zero to several weeks/months before resuming the sustained move in its original direction of the trend.
These outlying or outermost candles are commonly referred to as either poles, flags, shadows, or shoulders. The dimensions of these poles are measured by adding or subtracting their length from the high and low of the body that they project above (i.e., upper shadow ) and below (i.e., lower shadow ).
For example, if a pole projects 4 price bars above the candle's body then it will have an equivalent distance below it, resulting in what traders recognize as an asymmetrical flagpole.
On the other hand, a pole that is 6 bars long above the candle's body would measure out to be 3 bars in length below it, resulting in an asymmetrical flagpole.
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Bear Flag Pattern Rules
The bear flag pattern can be found on any time frame but it is most common to find them as swing low points within a 4-hour, daily, or weekly chart.
The setup of the flag itself (e.g. downturn in volume/upturn in price) is usually broad enough so that you can spot the pattern almost immediately after watching it develop over its 3-week lifespan…but don't try to catch it before you've got confirmation of divergence in momentum and then wait for a retest of support!
Because if you do that you're going to wind up with losses and have your confidence shaken—it's never fun losing money, especially if you thought the trade was good beforehand.
Although the exact numbers of price bars used to define a flagpole depend on personal preference, it's generally accepted that an acceptable upper shadow (or "flagpole") should occur 3 or more times above the previous candle's body and a lower shadow (i.e., pole) should occur below it 1 or more times.
The third candle that forms between the two outermost ones can then go either way since it will ultimately decide which direction prices will break in upon its close.
In other words, if this third candle closes higher, prices are likely to follow suit and continue rallying; but if they close lower, then prices are likely to resume their downward trajectory.
However, one thing to keep in mind is that even if the next candle after the flagpole forms, it will not necessarily mean that prices have broken out.
Rather, the first candle to form after a bear flag pattern should be viewed as just another candle and should be self-explanatory.
Basically, if prices close above the upper shadow of the bear flag then they have likely started their upward trajectory; however, if prices close below that "hidden" lower shadow this indicates a breakdown or downward continuation as opposed to a breakaway move.
Bear Flag Pattern Trading Considerations
Although some investors use technical indicators like moving averages (MA's) to gauge whether or not those patterns are forming, these can also be used in conjunction with chart patterns such as the bear flag.
As for stop losses, they can be placed behind the middle of the flagpole, which is sometimes referred to as a "neckline", and/or behind the pole's low point. This way, if prices break lower, that candle will likely act as a backstop for one's stop-loss order. Alternatively, investors can also use a stop placement directly below the bear flag pattern itself.
How to Trade The Bear Flag Pattern
Although the bear flag is one of the more common reversal patterns, it's no less important or reliable than any of its other technical charting counterparts.
In fact, it can be traded in a similar fashion as the well-known and widely used bull flags.
For example, if a stock has been rallying for several weeks/months straight but suddenly comes to an abrupt halt, this might indicate that traders are expecting prices to reverse and retrace their prior move back down.
Furthermore, this also means that they're probably looking for a lower low to occur before they resume their uptrend.
However, if these expectations don't materialize, then investors could continue buying at lower levels as prices start to break out of the pattern or attempt short below it if they don't.
The Bear Flag pattern is identified by the following:
- The stock has been trending down
- The stock has made a substantial rally to produce an upper shadow
- Following this rally, price closes near the bottom of the range
- A small bearish divergence forms (the close is substantially lower than the midpoint of the body and slightly higher than the low of each bar during a one-day period
- Price pulls back to retest earlier support, which corresponds with point 3
- As it moves up, it will generally create a pennant in shape
- Once price breaks out of this pennant, it can either make another run at resistance, in which case it will make another pennant, or it can indicate a bullish reversal and breakout
- If the breakout occurs, price tends to move up at 10-20% 9) The end of this pattern is oftentimes marked by an RSI divergence.
Knowing where to place your stop loss is key and depends on the time frame as well as risk tolerance.
Typically, I would have my initial buy order placed beyond both patterns with a breakeven price of around $0.15-$0.25 lower than that point depending on how strong or weak the bear flag is in relation to the overall trend of the stock, its underlying fundamentals, and any other factors which may be influencing it such as volume, news, etc.
Of course, you can adjust this depending on your situation but keep in mind that stops should always be placed below chart support levels and never where the stock has been trading for extended periods of time without seeing a reversal pattern play out first.)
The bear flag pattern can be very effective and rewarding for traders who are able to discern them correctly, but like all technical analysis patterns, it is not a perfect science. I would suggest that you test it out on at least one stock or option first before using it on positions with real money and never invest more than 5% of your portfolio into any single trade as this is more my rule than anything else (please see disclaimer below).
The bottom line is that this process is what makes technical analysis tick; as such, it's a good idea to learn how these patterns work before blindly trading them because you never know when new market habits might lead to an updated version of the old ones.
After all, many chartists refer to the bear flag as a "trendline trap" since price often returns back down into its previous trading range once broken... so make sure you know how to trade whatever version/pattern you come across in your own time!
As for me, I wrote this article so that my readers could discover why others use technical analysis, which is something every investor should do if they want to learn how technical analysis works.
Also, by learning what other investors are using you'll be able to recognize new patterns or chart patterns that develop on your own.
While I use this method purely for the sake of improving my own profitability, I would advise most novice traders not to trade these patterns until they've learned how ALL charting methods work because there's no sense in trading something if you have no idea why it works.
After all, nothing is better than trading a pattern that makes money while learning about how it works at the same time!
So keep this in mind as you read future articles since I'll often mention ways to improve your overall understanding and awareness of the market.
Until next time... happy trading everyone.
Disclaimer: Please keep in mind that past performance does not indicate future results. Traders should always assess each situation individually based on its own merits prior to making any trading decisions. This is especially true for those who are using the bear flag pattern as a potential entry point.