A price pattern is an arrangement of candles or bars on a stock chart that are recognisable as being this pattern or that pattern. Three useful flag patterns are rectangles, rising flags and falling flags.
Each of these patterns can be used to watch for a breakout from the pattern. When a breakout occurs the future direction of the stock price is “flagged”. Let’s look at some examples.
In the example (right), a rectangle has formed in a down movement. The continuation of the down trend was signalled when price broke below the bottom red dotted line which formed the base of the rectangle pattern. Price soon recovered in this case. However, a trader looking to go long on this stock would have been protected from entering a trade that was not profitable in terms of the chart shown. In this case, the trader would have wanted the price to break above the rectangle, which it clearly did not.
The next pattern to explore is the downward flag which has, in this case, occurred in a rising market.
The flag body is denoted by the trendlines with the series of green bars to the left constituting the flagpole. When price breaks out of the top of this pattern, the prior trend is likely to continue. In this case to the upside. Seeing price break out to the upside from a downward flag is a technical indication of the prior trend continuing. If we think about this a little further, we can say that price retraced from its prior uptrend only to return to the uptrend once a short term sell off was completed. Looking for price to break trend line in this way is useful as a means of confirming the trend direction.
The third pattern is the upward flag in an upward market. In this case price often breaks to the downside after the flag has formed. This pattern is less common, but provides an indication that if price breaks to the downside, there is a reversal of the prior trend forming.
