Flags are continuation patterns and they can be bullish or bearish, depending on the market they are appearing on. A continuation pattern is defined by a pattern that is going to move in the same direction with the prior trend, and the actual pattern to be considered a consolidation are and should be labeled with letters in terms of Elliott Waves structures. That area of consolidation is crucial in determining future price action and there are some factors to be taken into consideration, like the following:
- the actual consolidation area is channeling too well, corrections of a lower degree area almost the same, and no move is impulsive; it is usually being a zigzag family pattern, like a double or a triple zigzag, but it can also be a double or a triple combination;
- by the time price is breaking the upper/lower part of the channel a measured move can be applied in order to find future targets.
The measured move is being given by the distance price traveled prior to the consolidation area that is being called a flag, projected by the moment the upper/lower trend line is broken. Usually, price is breaking the consolidation area and goes for the measured move in less than the time taken for the flag to form, and that would act as a confirmation rule for the overall pattern.
Taking Time in Consideration when Identifying Flags
The recording below shows how the time element should be taken into consideration when identifying a potential flag pattern and the most important thing to be remembered here is the fact that they are continuation pattern, so if price is breaking a flag on the upside, we should look to buy call options, but if price is breaking the flag to the downside, we should buy put options.
The expiration date is to be given by the time frame the flag appears on and the bigger the time frame, the higher the expiration date should be so don’t be afraid to pick end of week or end of month expiration date (depending on the moment of time price is forming the flag).
Flags are Continuation Patterns
As mentioned at the beginning of this article, flags are continuation patterns and this is perhaps the most important thing to consider when looking at a pattern that resembles a flag. Continuation patterns are the ones you should look for when trying to add to a position or scale into one looking for a better average.
Another thing to take into account is the fact that flags actually have a different slope in the sense that after a flag is completed, the measured move or the thrust is coming in a different pace in a bullish flag than in a bearish flag. The reason for that comes from the difference between the two patterns in the sense that bullish markets always rise in a different angle than bearish markets are falling as bearish or downside is always associated with panic.
There is no panic buying, only panic selling, hence the speed market is moving after a bearish flag is stronger than after a bullish flag. For that reason, it is indicated that the expiration date for any option that derives from a bearish flag should be shorter than for an option out of a bullish one.
Flag Patterns – Consolidation
And then there’s the consolidation. It should be considered that markets spend most of the time in consolidation and only by looking at the FX markets and taking into account the Asian session and one can see that until early London traders are stepping in, markets are not really moving.
So if you’re looking for a consolidation area, or a flag, then look for it to form between economic news as when markets have no reason to travel then rarely they do. Asian session is just one example, but other situations are pretty much valid as well. For example, the first week of the month is always ending with the NFP (Non-Farm Payrolls) number and because no one is willing to take a chance, consolidation is the name of the game.
But then again, when you’re looking for consolidation, look for flags, as they are extremely rewarding. If the flag is forming on the hourly chart, then end of day expiration date should be the case by the time the upper/lower trend line is broken should be traded.
Flags are Equivalent of Corrective Waves
In terms of Elliott Waves Theory, flags are forming always as corrective waves, either as B waves or X waves, and rarely as legs of contracting triangles. There is always the possibility to look for put or call options after the B wave is retracing either below or above the golden ratio and if market is forming a zigzag, then most likely the pattern is a flag.