Forex Flags, wedges and triangles are characterized as continuation patterns. They usually represent brief pauses in a currency pair and according to research these patterns are some of the most reliable continuation patterns.
Flag is a small rectangle pattern which slopes against the previous trend. In case of bullish flag pattern, the flag would slope down where a break above resistance shows that the previous advance is resumed. In case of a bearish flag pattern, the flag would slope up where a break below support indicates that the previous decline is resumed. The most significant difference between flags and other patterns is that, they are usually too short in duration and do not have impact on highs and lows of the price. Here the price actions are limited by two parallel Forex trend lines, while this is not the case with other patterns.
Forex Flags are derived from price fluctuations within a narrow range and mark a consolidation before the previous move resumes. This pattern resembles a small flag with a flagpole. This graphical price model is a minor, short-term, trend continuation pattern that shows that the previous direction will prevail in the future after its formation. As for the daily chart the pattern is generally formed within a week.
The flag formation itself represents a brief consolidation period within a solid and upward or downward trend providing signals for direction and price objective. This pattern is represented by support and resistance trendlines, holding the range between high and low prices within, visually forming a parallelogram or a flag and generally directed against the main trend.
In current trend if the flag duration is longer than others it means that the trend is close to the end. The price will move down when the flag is upside down, i.e. it is below the flagpole. In the same way the price will continue moving up when the flag is in upright position. This pattern confirms the trend movement direction in case of breaking through:
- a sell signal arise if the pattern is formed in a downtrend and the price falls below the support line (plus certain deviation is possible);
- a buy signal arise if the pattern is formed in an uptrend and the price rises above the resistance line (plus certain deviation is possible.
The price depending on a flag pattern formation is believed to change in the same direction it was going prior to the pattern by at least the same amount as the price change from the start of the trend to the formation of the flag. The target level is calculated in the following way:
In case of a downtrend:
T = BP – (TS – PS)
In case of an uptrend:
T = BP + (PS – TS)
T – target price;
BP – breakthrough point;
TS – trend start point;
PS – pattern start point.