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Bullish and Bearish Flags.

Bullish Flags
In a bullish flag formation, initially the price shoots up forming a ‘flagpole’. Thereafter, the price consolidates by retracing in a narrow range with slight downward or horizontal bias. The high and lows of the retracement are connected to form the flag of the formation.

Bullish flags are typically continuation patterns. Therefore, a break of the higher trendline of the flag allows for the price to ascend.

The pattern is invalidated if the lower trendline of the flag is breached significantly.

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The following example of the GBP/USD five-minute chart illustrates a bullish flag formation. Initially, the pair rallied, creating the pattern flagpole. The pair then consolidated by trading in a narrow horizontal range, constructing the flag of the formation. Finally, the volatility exploded, allowing the pair to break out from the formation, indicating continuation of an uptrend.

Bullish flags typically represent a continuation pattern, we look for an opportunity to buy GPB/USD. Given that GBP/USD broke the bullish flag formation while heading higher, we believe that the pair will continue to rally. Therefore, we enter the position at 1.5945 and place our stop-loss slightly below the most recent significant low at 1.5890. Soon after breaking the formation, the pair ascends over 150 pips in the next couple of hours. Because this is a five-minute chart, the profits and risks are generally smaller than if the pattern appeared on a larger timeframe. However, the rise in volatility after the break of the formation resulted in nearly 3:1 reward-to-risk ratio.

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Bearish Flags
In a bearish flag formation, initially the price tumbles forming inverted flagpole. Thereafter, the price consolidates by retracing in a narrow range with slight upward or horizontal bias. The high and lows of the retracement are connected to form the flag of the formation.
Bearish flags are considered to be continuation patterns. Therefore, a break of the lower trendline of the flag allows for the price to descend.
The pattern is invalidated if the upper trendline of the flag is breached significantly.

How can we trade Bullish/Bearish Flags?
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In the following eight-hour chart of the USD/CHF, a bearish flag pattern emerged. Initially, the pair tumbled sharply, forming the flagpole of the formation. Thereafter, the pair consolidated by retracing in a narrow range with slight upward bias, constructing the flag of the formation. While drifting higher, the pair structured higher highs and higher lows. Finally, the pair breached the lower bound of the flag suggesting a possible continuation of a downward trend.

Because bearish flags are typically a continuation pattern, we look for an opportunity to sell USD/CHF. We sell the pair upon the close of the candle at 1.1350, while placing our stop-loss slightly below the most recent significant high at 1.1750. However, the pair does not descend right after breaking the lower bound of the formation. Instead the pair rallies briefly, but does not reach anywhere close to our stop-loss. Following a brief rise, the pair plummets all the way past 1.0900. Because this is an eight-hour chart, the profits and risks are generally larger than if the pattern appeared on a smaller timeframe. Therefore, the profit target and stop-loss should be adjusted accordingly.

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About Ziad Melhem

Ziad Melhem
Ziad Melhem is the Admin of Forex.com.lb with more than 10 years of experience in the local and regional "financial wheel". With vast experience in equities, capital markets, foreign exchange, derivatives, technical analysis, and financial services, he is one of the pioneers in online trading when this financial product was first introduced to Lebanon around 2000-2001. Ziad is currently the CMO of Amana Capital Group (www.amanacapital.com).

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