Bull and bear flags: how to identify and use them in crypto trading

Key Points

• Flags in technical analysis can indicate the feasibility of opening long or short positions in trending markets.

• Bullish and bearish flags are widely used trend continuation patterns that consist of three key elements: the pole, the flag, and the breakout point.

• Traders can combine flags with other indicators, such as RSI, to assess overbought or oversold levels of an asset.

Early identification of trends in digital asset trading allows traders to plan and execute trades more effectively. Chart patterns are an important tool used by many technical analysts to forecast price movements of cryptocurrencies.

Bullish and bearish chart patterns can signal the continuation or reversal of price movement. Flags are particularly popular in technical analysis as they provide valuable information about price trends and potential future movements. Flag patterns formed by lines and shapes on price charts help to identify future trends, breakouts, and reversals.

In this article, we will examine two types of flags - bullish and bearish, and explain how traders can apply them.

What are Bullish and Bearish Flags

Bullish and bearish flags are among the most common continuation patterns, typically formed when the current trend is likely to persist.

Bull flags typically appear during an uptrend when further price increases are expected. Bear flags are usually observed during a downtrend when increased selling pressure on the asset's price is anticipated.

Each flag consists of two main parts: the pole and the flag itself. The pole represents a significant movement upward or downward, depending on the type of flag - bullish or bearish. The formation of the pole is usually accompanied by a noticeable increase in trading volume.

After the formation of the pole, a consolidation phase follows. It resembles an ascending or descending parallel channel and forms a flag on the chart.

In bullish patterns, a pole is formed first, followed by a flag; in bearish patterns, the opposite happens.

Bullish and Bearish Flags: Key Differences

Characteristic

Bull Flag

Bear Flag

Market trend

Forms during an uptrend, indicating its continuation.

Forms during a downtrend, signaling further decline.

Price movement

A sharp upward movement (pole) followed by consolidation.

A sharp downward movement ( of the pole ) followed by consolidation.

Breakthrough Direction

Up: breakout above the flag resistance line.

Down: breakout below the flag support line.

Entry Point

When breaking the upper boundary of the flag.

At the break of the lower boundary of the flag.

Target Price Calculation

Measure the height of the pole and add it to the breakout level.

Measure the height of the pole and subtract it from the breakthrough level.

Placing a Stop-Loss

Below the lower boundary of the flag (support line).

Above the upper boundary of the flag ( resistance line ).

Volume and Sentiment

The volume sharply increases during a breakthrough upwards, indicating bullish momentum.

The volume sharply increases on a downward breakout, indicating bearish pressure.

Correction Level

Usually from 38.2% to 50% of the height of the pole.

Usually from 38.2% to 50% of the pole height.

Confirmation Factors

The RSI is approaching the overbought zone but confirms the upward trend.

The RSI is approaching the oversold zone but confirms the downward trend.

False breakout risks

A weak breakout upwards on low volume may indicate a trend reversal.

A weak downward breakout on low volume may signal a reversal.

How to Trade the Bull Flag Pattern

Flag patterns can be informative for predicting potential price levels for entering and exiting a trade. Flags also allow for an assessment of the possible magnitude of price increase or decrease. For both bullish and bearish flags, price movement after a breakout or sharp reversal usually corresponds to the size of the pole.

In the consolidation phase of a bullish trend, the price forms a rectangular pattern with a resistance line at the top and a parallel support line at the bottom.

Identifying the bullish flag pattern, traders determine the entry point. The breakout point is where the candle breaks above the upper boundary of the flag. This area serves as the entry point for buyers. The target for a bullish flag is a percentage increase equal to the height of the pole, added to the breakout point.

To minimize potential losses, some traders also set a stop-loss at the base of the flag, at the lowest point of the consolidation phase, as there is always a risk of losses if the price moves against the trade.

Some traders focus on the height of the pole to set their profit target. To determine the profit target, a trader must measure the height of the pole from its bottom to its top, and then add it to the breakout price.

How to Trade the Bear Flag Pattern

To determine the entry point on a bearish flag pattern, sellers subtract the height of the pole from the breakout price. This occurs when the asset's price drops below the lower boundary of the flag.

To limit potential losses, some traders set a stop-loss at the peak of the flag movement ( at the top of the consolidation phase ) in case the price moves in the opposite direction.

To calculate the height of the pole, you need to subtract the bottom point of the pole from its top point. The consolidation phase in both bullish and bearish flag patterns ideally should not exceed 50% of the size of the flagpole. A correction phase of more than 50% may indicate insufficient strength of the trend.

Additionally, the correction phase usually amounts to about 38.2% of the maximum movement - the top point of the pole.

When looking for an entry point for a short position, some traders wait for confirmation of a downtrend rather than simply placing an order after the price breaks below the flag's support line. This helps to avoid false signals and potential losses.

To limit losses in case the price starts to move in the opposite direction, a stop-loss order can be used. Typically, traders place the stop-loss above the flag's resistance line.

Example

Suppose you are trading the ETH/USDT pair on the daily chart and notice the formation of a bearish flag pattern. The lower line of the flag is at the level of $2,500, and the upper line is at the level of $2,800.

As a conservative trader, you decide to set a profit target based on the distance between the parallel trend lines on the flag. In this case, the difference between the two lines is $300, so you add this amount to the entry price at the breakout level, which is $2,400.

Thus, the price target is $2700.

To manage risk, you can place a stop-loss order above the flag resistance line, for example at the level of $2,900. If the price moves in the opposite direction, the stop-loss order will trigger, limiting potential losses.

Comparison of flags and pennants

Traders often confuse flags with pennants - another type of continuation pattern that suggests the trend is likely to continue after consolidation.

Like a flag, a pennant also has a pole. While the consolidation phase of a flag is rectangular, pennants form a triangular shape, where the consolidation period is formed by two converging lines.

How to Avoid False Flag Signals

Bullish and bearish flags can be valuable tools in technical analysis for determining target prices in trending markets. However, they do not guarantee expected returns, as false breakouts can occur. A false breakout happens when the price of a crypto asset breaks through a key boundary of the flag but then quickly retreats.

First, it is necessary to determine the presence of a sustainable trend. This can be indicated by either a bullish flag in a market with increasing interest or a bearish flag forming in a trend with weakening momentum. Volume is also of great importance, as a breakout is usually accompanied by strong movements.

Please note that traders often use combinations of indicators. The Relative Strength Index (RSI) is often used together with bullish and bearish flags to assess the overbought or oversold conditions of a crypto asset.

Conclusion

Mastering bullish and bearish flags can provide valuable insights when determining potential breakout opportunities in trending markets. These continuation patterns offer insight into price momentum and possible entry and exit points, but they should not be used in isolation. Combining the flag with other indicators, such as trading volume and the Relative Strength Index (RSI), helps confirm trends and minimize the risk of false breakouts.

As in all trading strategies, risk management plays a key role: setting stop-loss orders and maintaining an adequate position size help limit losses. By studying the nuances of these patterns and integrating them into their trading strategy, users will be able to navigate the cryptocurrency markets more confidently.