Flag Pattern – Follow Up Post

*Follow up from last weeks feature blog post with an example of a CB Flag continuation pattern trade*

Following on from last weeks blog post called, The Fable Flag Pattern, I thought it would be good to show you a live flag pattern trade that occurred last week using the exact same strategy and rules I showed you.

From experience, I know it is very easy to read through other peoples strategies and then quickly feel “lost” in the real world of the financial markets and forget everything that was explained to you. Therefore, I am using this post to re-iterate the key points of my flag pattern strategy and show you a nice example that presented itself last week on a financial instrument that wasn’t an FX currency pair! Shocking right.

Firstly, lets go over the main rules to the strategy.

  1. Clear momentum move in a single direction.
  2. Price finds temporary support and consolidates.
  3. Price tests and rejects the 0.382 fibonacci retracement level.
  4. Price tests and rejects the 50 ema from above/below (depends on direction of trade).
  5. 3rd touch and rejection of the top trendline of the flag.

So why do I look for these rules to be met? Well, the momentum needs to be present in order for the probability of it to continue again to be high enough. The consolidation is the opportunity for you to get a better reward:risk entry instead of selling at the bottom of the momentum move. By waiting for confirmed rejections of the fibonacci levels and 50 ema, you are confirming they are now acting as support/resistance for price and this will then benefit your trading bias. The 3rd touch rejection of the top flag trendline gets its foundations from the Elliot wave theory and the patterns in which the majority of markets move. By waiting for a 3rd touch you are waiting for the 5th wave of the consolidation to be completed which is normally when price will then continue in its next wave of the larger pattern.

To read about the rules in more detail including stop loss placement, risk management and profit taking then please click on the link below to go to the original blog post.

https://diaryofafinancekid.com/2019/07/11/the-fabled-flag-pattern/

Below is the simple line chart I used in the previous blog post to explain the key parts to my flag continuation pattern strategy.

CB flag continuation pattern strategy example

I highly recommend you keep a copy of this example near your charts if you are planning on trading using my strategy. It will help as a reference to check against when you think you have found a potential flag pattern trade.

Now let’s look at a near perfect example of a trade that appeared on the US Oil CFD instrument last week. I will talk you through the before and after of the trade so you can see why it ticked all of the rules of the strategy.

US Oil 1 hour timeframe chart
(before short position entry)

Price was making a nice 1hr downtrend prior to the flag continuation set up but I was yet to entry because although price was making lower highs and lower lows, it was still residing above the 1hr 50 ema. Therefore there was a high chance it would act as dynamic support for price until broken next.

After a large wick rejection candle that actually took out the 2 previous lower highs, price snapped to the downside and broke through there $60.00 support level and 1hr 50 ema in one single bearish candle. This is the momentum I was looking for.

Price then found some support at $59.20 before pulling back and consolidating. At this stage I now saw rules 1 and 2 of my strategy had been confirmed and because price was below the 1hr 50ema and 0.382 fibonacci retracement level, I was looking for rejections of these levels next. At this point, it is quite easy to forecast where that might occur by adding the fibonacci retracement levels and flag trendlines to the chart. See chart below.

US Oil 1 hour timeframe chart
(with all rules confirmed)

It is then just a case of being patient and waiting for those all important rejection candlesticks to appear at the 59.82 zone. The rejection of this level is very important because that is what proves that they are holding strong as resistance to keep price down and further help the probability of the bearish momentum continuing.

TOP TIP: If you are struggling to see clearly, the flag pattern and number of waves that have occurred so far then draw over the chart with the line tool. Then remove the candlesticks and see what is left over.

I have done this for this US Oil short trade example and you can see the results below.

Lines joining highs and lows of candlesticks.

As you can see, just by drawing a simple line connecting the highs to the lows from before the initial momentum move to the current (3rd) touch of the consolidation, it makes the flag pattern much clearer. In my opinion, I think this US Oil trade example from the 16th July 2019 is a fantastic and almost textbook example. The 5 waves of the consolidation and the 3rd touch of the top flag trendline is very clear to see.

US Oil 1 hour timeframe chart
(with short position marked on)

The stop loss placement and take profit placement are exactly as my strategy states. Keep the stop loss above the previous candle highs and the fib 0.382 and 50 ema to avoid any further retests. Target profit should be set at the -0.618 fibonacci extension level for maximum reward:risk and to capitalise on the momentum continuing.

With this simple set up and stop loss and take profit levels set at where they are, this US Oil flag continuation trade produces a possible return of over 4.7R. Let’s look at how the trade played out.

US Oil 1 hour timeframe chart
(post trade)

As expected, the bearish momentum that appeared in the markets, before this consolidation flag pattern formed, then returned with multiple large bearish momentum candles forming on the US Oil 1hr timeframe chart. The profit target was achieved within 3 hours of entering the short position.

Common mistakes.

I go in to more detail about the common mistakes people make when trying to trade flag continuation patterns in the main blog post (click here), but I will use this example to show you again why I enter flags when I do.

A lot of forex trading courses and “gurus” who appear to be less educated than a garden shed, teach you to enter on the break out of a flag pattern but I will again show you why this is futile and damaging to your returns.

On this US Oil short trade example, using my CB flag continuation pattern with the entry on the close of the candlestick rejecting the fib 0.382, 50 ema and top flag trendline, the return is 4.7R.

Let’s now look at the potential reward vs risk of a breakout entry taught by others.

US Oil 1 hour timeframe chart
(breakout entry method)

As you can see from the chart above, I have used the same stop loss placement and target profit location but I have moved the entry price to the close of the 1hr breakout candle. What does this do to your potential returns?… it more than halves them! That’s right, less than 50%.

If you aren’t aware of the relationship between reward:risk ratio and win rate then I recommend you read up on it. It the fundamental basis to long term returns and by halving your R:R ratio for trades like this you are then going to have to double your win rate to maintain the same performance.

Doubling a win rate is infinitely harder than doubling your reward:risk ratio.

So there we have it, a recap of the rules of my CB flag continuation pattern trading strategy and a recent example of how and why it works.

I hope you enjoy this post and get some benefit from it. Please remember to LIKE, SHARE and FOLLOW my blog to stay up to date with the latests posts and market analysis.

DISCLAIMER: None of the information posted on this site is to be considered investment/financial advice. Trading is high risk and you should only trade with money you can afford to lose.

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