Previously we have discussed one type of continuation pattern, Triangles. Flags and Pennants are two common continuation patterns that are similar. They often appear in the same place in the direction of the price. Both have the same criteria for trading volume and measurement.
The appearance of these patterns indicates a temporary pause in the active market movement. One of the requirements for their appearance is a sharp price movement in the form of a straight line, which occurs when the price experiences a sudden increase or decrease. This occurs so that the market can catch its breath for a short period before resuming its movement in the same direction.
These patterns are considered to be among the most reliable continuation patterns that traders can rely on. They rarely result in a reversal in direction.
We notice a sharp price increase before the formation of the Flags and Pennants chart patterns, accompanied by intense trading volume (i.e. lines below). The trading volume then decreases as the price consolidates within these patterns.
After the price breaks above the upper boundary of the pattern, there is a sudden and sharp increase in trading activity. It confirms the end of consolidation and indicates the continuation of the price movement in its previous direction. Although these patterns are continuation patterns, traders should carefully monitor price movement and trading volume to determine the correct market direction.
The structure of the Flags and Pennants chart patterns differs slightly: The Flag pattern resembles a rectangular or parallelogram shape with two parallel lines that oppose the general trend. The Pennant pattern can be recognized by drawing two converging lines at one point. When these patterns form, trading volume must be low.
Both patterns are formed over a short period, ranging from one to three weeks. When the general trend is bearish, these patterns take less time to form (from one to two weeks.)
A signal of completion for these patterns is indicated by breaking one of the upper or lower boundaries with high trading volume. Increased trading volume during an uptrend is more important than during a downtrend.
Measure the amount of price movement after the pattern is completed
The method of measuring the extent of price movement after the completion of the Flag and Pennant patterns is similar. Both patterns form in the middle of price movement.
Often, the price movement after their completion is less than the movement that occurred immediately before them (either a sharp rise or a sharp drop).
One way to measure the extent of price movement is to start from the beginning of the current trend direction (which is formed by breaking an important support or resistance level or breaking an important trend line) and draw another line by the same distance from the point of breaking the upper boundary in an uptrend or the lower boundary in a downtrend.
How to define price targets
As we said, the Flag Pattern has a continuation potential on the chart. And so, a valid Flag pattern is likely to push the price action further in the direction of the Flag Pole – the trend impulse. In addition to this, when you spot a Flag formation on your price chart, you will be equipped to measure the approximate price target of the formation. There are two targets related to the Flag chart figure:
Target 1: the size of the Flag
A confirmed Flag pattern can reveal its initial target by utilizing the measured move technique. This involves calculating the size of the flag, which is determined by measuring the vertical distance between the upper and lower channel within the flag.
Once you have determined the size of the flag, you can apply this distance from the breakout point to identify the location of your first target. This target is located at the end of the calculated distance.
Target 2: the size of the Pole
To determine the next target for the Flag formation, measure the vertical distance between the high and low points of the Flag Pole. This distance should be applied to the pattern to obtain Target 2, starting from the breakout point, just as we did for Target 1.
In the above sketch, there are two targets depicted. The initial target is identified by magenta arrows and lines, and it measures the vertical dimensions of the flag within the blue channel. The second target is indicated by purple arrows and lines on the chart, and it measures the vertical size of the flag pole.
The Flag and Pennant continuation patterns indicate a temporary pause in price movement for a period ranging from one to two weeks, with low trading volume. These patterns form in the middle of price movement and are preceded by a sharp price movement and increasing trading volume.
The Pennant pattern resembles an ascending triangle but is more horizontal, while the Flag pattern resembles a parallelogram that slopes in the opposite direction of the general trend. The formation of both patterns takes a shorter time in a bearish trend.