1450 Flag Forex Trading Strategy
Pattern trading is one of those strategies out there that just simply works. It’s been tested, studied, traded and proven to bring in the dough. However, many chose to ignore this type of strategy because it just seems too simplistic. Others think it just doesn’t make sense. While others just wouldn’t want to put in the work to become proficient in identifying patterns.
I’ve met traders who just don’t believe in pattern trading simply because they don’t think patterns just don’t seem to make any sense in trading. But when you come to think of it, patterns represent a repeated behavior among many traders which are expressed on a chart. The patterns form a certain way because traders respond in the same manner and for the same behavioral reasons to certain market conditions.
For example, a triangle represents a market congestion. This means that volume is gradually getting lower and lower as traders move to the sidelines waiting for the next big push, which usually happens at the breakout of a triangle pattern.
An ascending or descending triangle on the other hand is the same market congestion, only that the congestion has become one sided. This means that on an ascending triangle, the bears are just trying to hold the line, while the bulls are still trying to push the market. As the bears fail to hold the resistance level, the market enters a rapid bullish expansion, and vice versa.
The Flag Pattern – What does it mean and why it works?
Flags and pennants are continuation patterns that occur after a rapid market expansion. The rapid market expansion is represented by the pole of the pattern. Then, after the rapid expansion phase, the market enters into a congestion phase forming a sideways pattern or a retracement. This contraction phase forms the body of the flag or pennant.
Flags and pennants are different patterns but have the almost the same characteristic and effect, only that they have a slight difference in shape and pattern. Flags have more of a perpendicular support and resistance on the body. Pennants on the other hand have a bit more of an asymmetrical contraction phase that gradually gets tighter. In a way, this tightening of support and resistance means that the volume is gradually getting thinner, much like the triangle pattern. This makes pennants very powerful because as the pent-up volume enters the market, it causes a sudden spike on the expansion phase, although flag patterns also do tend to have these types of expansion phases often.
So, why does it work? First, it is the typical cycle of expansion and contraction of the market. This means that it is quite predictable that as price breaks support or resistance on a flag pattern, the next phase would be a sudden expansion. Another reason would be that flags are typically retracements, which means that entering during this phase in the market could allow a trader to enter on a fresh thrust going the same direction as the established trend. Lastly, it is a continuation pattern which means that often times we are trading with the trend.
Trading Strategy Concept
Although flag and pennant patterns are high probability patterns, many traders find it difficult to trade. This is because identifying it is quite difficult to an untrained eye.
The idea behind this strategy is to use moving averages to identify the area in which could expect flags and pennants to form after a sudden thrust. To do this, we will be using the 14-period and 50-period Exponential Moving Average (EMA). After a sudden thrust, we will be waiting for price to retrace to the area between this two moving averages. Then, we will try to identify flag or pennant patterns on it. If we could identify one, then we wait for the breakout and trade accordingly.
We will also be using the 200 EMA to help us identify trend. This means that price and the other two EMAs should be on the correct side of the 200 EMA. This also means that all three EMAs should be stacked depending on the direction of the trend.
Indicators
- 14-period EMA (Gold)
- 50-period EMA (Green)
- 200-period EMA (Brown)
Timeframe: any
Currency Pair: any
Trading Session: any
Buy (Long) Trade Setup Rules
Entry
- A bullish price thrust should occur
- Price should be above the EMAs
- The EMAs should be stacked in the following order:
- 14 EMA: top
- 50 EMA: middle
- 200 EMA: bottom
- Wait for price to retrace between the 14 & 50 EMA
- A flag or pennant pattern should be identifiable
- Wait for the close of the candle which breaks out of the resistance line
- Enter a buy market order at the close of the breakout candle
Stop Loss
- Set the stop loss at the fractal below the entry candle
Take Profit
- Set the take profit at 2x the risk
Sell (Short) Trade Setup Rules
Entry
- A bearish price thrust should occur
- Price should be below the EMAs
- The EMAs should be stacked in the following order:
- 200 EMA: top
- 50 EMA: middle
- 14 EMA: bottom
- Wait for price to retrace between the 14 & 50 EMA
- A flag or pennant pattern should be identifiable
- Wait for the close of the candle which breaks below the support line
- Enter a buy market order at the close of the breakdown candle
Stop Loss
- Set the stop loss at the fractal above the entry candle
Take Profit
- Set the take profit at 2x the risk
Conclusion
This is a strategy that many traders have been profiting from. In fact, there are traders who claim to have more than 100% return on their profits year-on-year with this type of strategy, and even more.
It is simple and is logical on a behavioral standpoint. We could now explain why it works based on how the market thinks.
However, not all patterns should be taken right away. Avoid trading expanding patterns as this means that the market is not congesting but is rather gradually expanding, lessening the likelihood of a rapid expansion phase on the breakout. This also makes identifying support and resistance a bit harder as these lines would often be moved on expanding patterns.
Other traders also prefer to trail their stop loss as their exit strategy. This could work on a strongly trending market with less hurdles along the way. However, during slowly trending markets, this strategy could fail because you could be taken out of the trade before the trend ends.
Others also set their take profits differently. Some set take profits at the high or low of the thrust or pole of the flag pattern. Others use the pole as a measuring stick on how long the next thrust could be. Others use a Fibonacci expansion method which allows them to set stop losses at a Fibonacci expansion level.
Study this concept and you could also be one of those making money out of these patterns.
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