There is a small handful of price patterns I consider and when looking short, I like to use the bear flag chart pattern. Although I wrote about the bull flag pattern (and the bear flag is the opposite), I know people enjoy a proper explanation of most things trading related.
Let me be clear that I don’t get too caught up in the minute details of any chart pattern.
I don’t need it to fit a textbook definition which is why, for me, these are just a pause in the current market direction and are treated as a continuation pattern.
What Is A Bear Flag Pattern
In order to spot a bear flag, you must be in a market that is heading down. As a market heads down, those that are short start to take profits and, at times, buyers step in to help price rally against the main trend direction.
These are not hard price patterns to see on any chart and really, you just need to spot them and have your entry trigger to get into the trade.
Let’s break the pattern down:
- We need to see the initial thrust down in price. We would like to see momentum to the downside and this leg of the price action, is called the “flag pole” You’ll understand the relevance of this leg of price in a moment
- After that move down, we need to see price action against the first move down so price needs to find support. While momentum in the move down is preferred, during the flag formation (the pullback), we’d like to see lazy price action where bulls don’t step up too strongly (or too many shorts unload their positions).
- Look for price to resolve back in the direction of the previous trend move to the same extent as the first leg (flag pole)
So what does that mean from a trader point of view?
- We are getting a steady move down with small ranging green candles which shows buyers aren’t too interested in defending lower prices
- Price begins to rally and the candles that make up the rally, the bearish flag, don’t appear to show much buyer interest so shorts are still in play
- Price has begun to break down, with one big move which shows seller interest so we measure the move into the low before the rally
- The move from 3 is projected from the high at 2 to give your price target
I didn’t pick a perfect example with big thrusting downside move as the pole because rarely do we see perfection.
It’s the understanding of what you are seeing that matters.
- Price is moving down with very little buyers stepping in. Traders on the sidelines are looking to enter and those in short are looking to profit
- Price rallies and traders that are short, look to take their gains. Sellers on the sides see their opportunity to short
- Once price starts to break down in the bear flag, sellers look to enter. This is made more interesting when the first leg down is strong
You’ll see other articles about needing “sharp” price action and other variables. While the sharp action would be nice and shows strong seller intent:
- The sharp price action doesn’t always happen in a steady decline
- Sharp price action can also be an exhaustion move and you’d not be looking to short on the formation of the flag
Once you get the hang of it, the bear flag pattern is fairly simple to trade.
Bear Flag Trading Strategy
Let’s go over a strategy you can use for trading bear flags.
- We need to determine a down move in price action that looks like it deserves another move in the same direction
- Look for price to begin to rally to the upside
- Use a sell trigger to enter a trading position
- Place a protective stop using various techniques
- Look for a measured move price target or other profit taking strategy
Let’s take a look at this Forex chart and cover the first two bullet points of the strategy.
Are we moving down?
We can see an obvious double top that has it’s support break which, following double top pattern rules, confirms the reversal to the downside.
Price may not be thrusting to the downside but we see more interest to the downside than price heading back up.
Has price begun to rally?
Price has found some support and after a brief range, a rally began. We are not seeing strong momentum to the upside and we draw channel lines to contain the price. We need to see a slow counter trend move in the flag.
Now we need to find a trigger into the trade and set our stop loss.
We need a trade trigger.
I wrote an article on trade entry triggers but in short, you could trail a sell stop order below the lows of each candlestick during the rally. You could wait until a certain number of candlesticks are in the rally to begin the trail. You can even use any number of trading indicators such as the MACD and enter when the fast line hooks in your direction.
Lower time frames come in handy. Using a five minute chart, we can use trend lines as a way to enter a trade.
Use a stop loss.
There are several methods to place your stop loss but I default to the average true range method. Using a 14 period ATR in this example, I set the stop 1.5 ATR from trade entry for the stop. You can also place your stop just over the high the final candlestick during the rally.
Now we are in the trade, profit targets come next if bears want to drive market lower.
How do you exit a bear flag trade?
To find an exit location, we take what is called a measured move. We measure from the peak of the leg down to where price found support. We then project that distance from the highs of the rally.
The reason this is a viable approach is that unless something changes in the market, we can expect the same type of volatility as we saw in the immediate past.
Price won’t always hit the price exact but I have found this method of taking profits extremely reliable.
You also have the option of trailing your stop which may not be a bad idea if you’ve caught a trade at the reversal from an uptrend to a downtrend.
Bear Flag Pro Trading Tip
I have found one way to improve this trading pattern is to look for the flag to terminate around a previous zone of support, resistance, or previous trading range.
This is a 30 minute stock chart and the context is price has broken previous support so we want to sell.
- Obvious sellers here and price breaks down. We do see a push up with momentum that is immediately wiped out
- Price finds support after breaking down and begins to rally. Notice the candlesticks and the lack of strong upside momentum in this bear flag formation
- This is a previous range where we have a string of inside candles. Price has rallied into that zone and stalled
- After price has broken down, this line is the length of the flag pole projected from the highest point in the flag
By using a price structure such as a range, we have a zone where price had previous seller/buyer battles. Those are always a good place to look for another trading opportunity.
Trading with bear flags takes advantage of the normal ebb and flow of price movement.
Ensuring the flag pole shows strong interest to the downside adds to the probability of a continuation after the rally.
Using price channels around the flag gives you a “built in” trade trigger when price breaks the bottom trend line. Your stop loss can be an average true range from entry or use the highest high of the bear flag.
Target is roughly the same distance as the first push down in price. You could either exit the trade or use any number of the trailing stop techniques available.