HOW TO TRADE BEARISH FLAG CHART PATTERN

How to trade bearish flag chart pattern
Infographic - How to trade bearish flag chart pattern

Entry: after breaking the flag's lower border at point (4)

Take profit: identified by measuring the flag's pole height, which is the vertical distance between points (1) and (2), that measurement is then applied from the breakout rate (4)

Stop loss: the flag's highest high (3)

BEARISH FLAG PRICE ACTION

This chart pattern starts forming with bears already in control of the exchange rate's sharp downtrend. When bulls enter the market, trading is contained briefly in an up-sloped range. Bears then break that range's lower resistance, and the exchange rate continues its downtrend.

Let's break down the pattern formation!

A sharp downwards price action is initiated from (1) till it finds the first resistance (2), creating the flag's pole.

Price action reverses direction from the first resistance (2) and starts forming higher lows and higher highs in a narrow flag-like formation, till it finds the highest support in that formation at point (3)

The pattern is completed when price action reverses direction from the highest support (3) and goes downwards till it breaks the flag's lower border at point (4)

NOTES ON BEARISH FLAG

Direction

Continuation

Type

Bearish

Occurrence

High

Common term

Short-Medium

Before the breakout, at least two lows (including the flag's pole low) and two highs are the minimum for a valid pattern, more touches are acceptable.

The flag's pole is a sharp downwards price action.

Volume is usually high at the flag's pole, as well as when breaking the flag's lower border.

This pattern is commonly found on short-term and medium-term time frames.

BEARISH FLAG REWARD:RISK

This pattern is known for its high R:R.

R:R depends on how narrow the flag formation (2-3) is, compared to the flag's pole height (1-2)

Always remember that the stop loss level explained above is absolute, the actual stop loss rate for your trade setup should be a bit beyond those levels to give the trade setup some room to breathe, and of course, calculations for position size and R:R should be done with respect to that rate.

BEARISH FLAG REAL TRADE

Bearish flag real trading example
Forex chart - Bearish flag real trading example, as found on the H1 chart of AUD/USD using XM's MT4 platform

PRE-BREAKOUT CALCULATIONS

Since a bearish flag chart pattern can be spotted after the reversal from point (3), you can save yourself precious time by doing the following set of calculations before the breakout, since they don't rely on the trade's entry rate.

  • Pattern length (point (1) rate - point (2) rate)
    • (0.74129 - 0.73004) * 10000 = 112.5 pips
  • Take profit rate (point (3) rate - pattern length)
    • 0.73385 - (112.5 / 10000) = 0.72260
  • Stop loss rate (point (3) rate + 20% of pattern length)
    • 0.73385 + ((20 * 112.5 / 100) / 10000) = 0.73610

TRADE SETUP

Choosing when to enter the trade after the flag's lower border breakout is always left to your best judgement. In this trade, we chose to enter the market at the closing rate of the candle that broke the flag's lower border. This entry is arguably a high risk one, since the bearish candle that broke the flag's lower border was a short bearish candle, which doesn't strongly suggest a true breakout. Another reason that makes this a risky entry is that the breakout candle closed before breaking the flag's pole resistance (2), entering after breaking that resistance would have resulted in a less risky trade, with less expected profit.

  • Trade entry rate
    • At the closing rate of the candle that broke the flag's lower border at point (4): 0.73214
  • Take profit in pips (entry rate - take profit rate)
    • (0.73214 - 0.72260) * 10000 = 95.4 pips
  • Stop loss in pips (stop loss rate - entry rate)
    • (0.73610 - 0.73214) * 10000 = 39.6 pips
  • Stop loss R:R (take profit in pips / stop loss in pips)
    • 95.4 / 39.6 = 2.409

Currency pair

AUD/USD

Timeframe

H1

Breakout

03-Sep-2020

Platform

MT4

Broker

XM