Over the last couple of weeks, we’ve looked at the “head and shoulders” pattern from all angles.
We saw that the pattern can be either bullish or bearish and can act as either a continuation or reversal pattern.
You’ve also heard me talk about the “high-tight flag” and the “cup-with-handle,” which are some of my favorite advanced trading patterns.
But today, I want to break down a more basic pattern and look at the bullish “flag” setup.
Let’s dive right in…
Find the Flag
For any flag to fly, the first thing you need is a “flagpole.”
Because a flag is really just a consolidation period, the first thing we need to see before a consolidation is a directional move.
And in trading, this is what we call the flagpole. It is typically formed by a short-term move to the upside with few pullbacks.
In the example above, we’re looking at a daily chart of The Home Depot, Inc. (HD).
As you can see, the stock made a nice upward move throughout October 2021, gaining about 14%.
This move represents the “flagpole” in this example.
But after such as a strong move, a consolidation was to be expected. And that’s exactly what happened.
You can see that the stock subsequently traded in a narrow range for about three weeks.
This sideways action represents the flag in this example.
Now, the whole reason that we’d want to go look for flag patterns is so we can be there for the breakouts!
And because these flags are just sideways consolidations with horizontal upper boundaries — like many of the setups I bring to your attention — the breakouts can be really strong.
Just take a look at how the move in HD played out…
After breaking out from the flag pattern, HD gained another 12% before some profit-taking started.
In this example, that makes perfect sense. Why?
Because it is often said that the move following a flag breakout will be roughly equal to the move before the flag.
In other words, because the flagpole showed a move of 14%, traders would expect a breakout move of approximately the same magnitude.
Of course, it’s rarely going to be a perfect match, but that’s the general rule for flag breakouts.
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Embrace the surge,
Editor, Stock Surge Daily