Big Bad Bear ..... Flags

Without question of all the elements of TA, chart patterns are my favorite. For whatever reason, recognition comes easy to me, in fact too easy which is probably why it’s my favorite. I wanted to introduce you to one of the prominent patterns, the bear flag.

A bear flag is a bearish signal, indicating the current downtrend may continue. It follows a steep, or nearly vertical decline in price (the flagpole), and consists of two parallel trend lines that form a rectangular flag shape. The flag can be have an upward tilt or be horizontal as is shown in my example.

financial advisor bay area, cfp, investment management expert

The rectangular flag shape is the product of consolidation. Consolidation occurs when the price bounces between an upper and lower price limit. This is a place where buyers and sellers are attempting to determine price equilibrium. A bearish signal occurs when the price falls below the lower trend line of the flag and continues downward. The break of price below the flag is considered pattern confirmation. There are other elements you want to see during the formation of the flag that add to the probabilities of success (eg, volume and period of consolidation) but for now, I just wanted to focus on price.

The target of the pattern is the length of the pole subtracted (or in the case of a bull flag added) from the price where it broke down below the lower trend. Keep in mind price does not have to go to the target. It can fall short or even extend much further. So, just because you get confirmation does not mean you can ignore investment.

This pattern is effectively a pause in a downtrend. The price has gotten ahead of itself; therefore market activity takes a break before continuing the downtrend. You would like to see this pause reflected in decreased volume. Similarly, a spike in volume will hopefully mark the resumption of the downtrend.

Armed with this understanding, I present a daily chart of the SP500.

Financial Advisor Bay area, Certified financial planner 2-3-15 - spx

If we get a breakdown below the flag trend line, the target for this move would be down at 1680 some 11+% lower than today’s close. There are no guarantees but it is something for investors to think about.

In case it doesn’t jump out at you, there was another bear flag that formed during the last decline in August. I did not highlight it on purpose to see if any readers found it on their own. You can see price broke decisively down below the (not drawn) flag with very high volume which was the confirmation validating the pattern. But notice how price stopped around 1860 and never reached its measured move of ~1750.  I believe this time may be different and have a much better probability of hitting the target on a breakdown of this flag mainly because instead of a sideways consolidation that occurred before the top of the pole that we had in August, this time we was preceded with downtrend, lower highs and lower lows.

Nobody has a crystal ball but I know where and when I will be laying my chips on the table come a break of the lower flag trend line (support).