The bear flag pattern gives us a simple and reliable piece of information – the current downtrend is going to continue, and prices will continue to drop. The appeal is easy to understand- as one of the most straightforward chart patterns, bear flags are both easy to spot and easy to use.
A bear flag occurs when a sudden and sharp drop in price is followed by a short consolidation period – which is in turn followed by further drops in price. In pronounced downtrends, the chart pattern has a success rate close to 67%. With proper risk management and reasonable price targets, this can be a great tool to identify trades.
This chart pattern forms over a period of days to weeks, so it falls squarely into our preferred method of swing trading. Beyond that, bear flags also give traders very clear entry points, profit targets, and stop-loss placements.
This chart pattern is great for identifying short-selling opportunities – and although simple at first glance, there are a lot of small details you need to be aware of to unlock its true potential as a trading tool. If you’re interested, let’s go over everything – from the basics to the fine print and the devil in the details.
What you’ll learn
The Definition of a Bearish Flag Pattern
The bearish flag is a bearish continuation pattern – in other words, it tells us that an existing downtrend will continue.
It consists of two parts – the flagpole, representing an initial drop in price, which consists of a single large bearish candle (similar to a bearish engulfing candle), and the flag itself, which represents a consolidation period. Let’s use a real-life example.
The stock has been in a downtrend for a while, and the recent disappointing earnings report causes the initial plunge that begins the formation of the chart pattern.
This is a very textbook, clear-cut example – a downtrend is present, and after a sudden and drastic drop symbolized by the large red candle (the flagpole), a short consolidation period follows.
Once the consolidation period is over, the stock continues making significant downward moves – and it’s clear to see that this was a great opportunity to short Musk’s company.
What Does a Bearish Flag Tell Traders?
The bear flag stock chart pattern is a sign that a bearish trend will continue. The flagpole of the pattern represents a rapid decrease in price – and such abrupt changes lead to uncertainty. Even the most bearish trader will stop to think whether or not further shorting is warranted.
While the bears take a break to lock in gains, the bulls are attempting to push the price higher – however, this doesn’t pan out, and the price enters a short consolidation period. After that, further drops ensue.
In essence, the trading psychology behind it works like this – after a sudden drop, a portion of sellers become cautious and wait to see whether or not a significant upward correction will occur. While there is some upward price action, the flag is a clear demonstration that even when the most risk-averse bears take a break, the rest of the sellers can still keep the bulls at bay.
Once it becomes clear that this is the case, even more sellers pile into the market – driving prices further downward. As straightforward as that may sound, chart patterns aren’t crystal balls – you do have to know what signs to look for to confirm their veracity.
How to Trade the Bear Flag Pattern
Not all chart patterns are created equal – what’s more, not every chart pattern is legitimate. Simply seeing something that looks like a bear flag isn’t a guarantee that a downtrend will continue – traders need to use other metrics to determine whether the pattern is legitimate.
In the case of the bear flag, the best way to do that is via volume. Ideally, the initial drop in price should happen on strong volume, while the flag or the consolidation period should be formed with lower or even declining volume.
On top of that, an increase in volume once a breakout occurs is a strong sign that the chart pattern in question is the real deal.
As for actually trading, don’t rush in – while it might be tempting to enter a position as soon as the pattern starts forming, this is way too risky. Instead, positions should be entered once the price moves below the lower trendline of the flag.
Profit targets should be set by taking the length of the flagpole and tracing it downward from the breakout. When it comes to stop losses, they should be set either at recent swing highs or at the highest point in the “flag” portion of the pattern.
What’s the Risk-Reward Ratio?
The risk-reward ratio is a simple metric used as a risk-management tool. In essence, it shows how much potential return a trader can earn for every dollar risked.
There are a couple of good rules of thumb to keep in mind here – traders with a risk-reward ratio of less than 1:2 should generally be avoided, although 1:1.5 is acceptable in case of very strong trading signals, while trades with a risk-reward ratio of 1:3 and above are ideal.
There is no risk-reward ratio specific to the bear-flag pattern, or any other stock chart pattern for that matter. However, as this is a strong continuation pattern, placing a stop loss at the high point of the flag or a recent swing low, while setting a profit target equal to the flagpole’s length below the breakout should, in most cases, lead to very favorable risk-reward ratios.
Research from industry expert Tom Bulkowski suggests that bear flags lead to an average price decline of 8%. With that in mind, calculating both profit targets and stop losses that combine for a favorable risk-reward ratio shouldn’t prove to be too challenging an equation.
How Reliable is the Bear Flag?
Research suggests that the bear flag pattern has a 67% success rate percentage – making it one of the more reliable chart patterns. While statistics such as these give us an idea as to how reliable certain patterns are in comparison to others, a wise trader knows that everything should be approached on a case-by-case basis.
So, instead of giving you an abstract figure like 67%, let’s focus on actionable advice that will help you determine whether a bear flag is worth following up on.
First of all, while bear flags occur frequently and on many timeframes, the shorter the time frame, the less reliable the signal. In general, bear flags that form over a couple of days to a couple of weeks merit your attention – anything shorter than that is simply not worth the risk.
The second order of business is volume – strong volume on the flagpole, low or dropping volume in the flag itself, and an increase in volume on the breakout is the ideal scenario. And last but not least is flag retracement – statistically, bear flags where the price climbs up less than 38% of the flagpole are the most reliable – and anything above 50% is considered a false signal.
Risk Management in Trading Bearish Flag Pattern
Managing risk is crucial for any trading strategy. First of all, keep in mind position sizing. A commonly utilized rule is to use no more than 1% to 2% of your account worth on any given trade. This ensures that the odd loss or even losing streak doesn’t diminish your account too much.
Next, look for confirmation. In the case of the bear flag pattern, this happens when the price moves below the flag’s lower trendline on rising volume, signaling a breakout. Alternatively, you can make use of stock or option trading alerts that will let you know when this occurs. Once the chart pattern is confirmed, you need to define profit targets and stop-loss placement.
When it comes to profit targets, traders usually take the length of the flagpole, apply it to where the breakout occurs, and set profit targets there. As for stop losses, the highest point in the flag or a recent swing high will usually suffice.
Risk management can also be approached from another direction – by making use of options contracts. Several advanced strategies for trading options, such as bear put spreads, offer a cheap way to profit from drops in price with limited and clearly defined risk.
Pros and Cons of Bear Flag Pattern
The bear flag pattern is quite simple and easy to identify. Along with this, it also occurs quite frequently, while also providing traders with clear entry points, as well as simple profit targets and stop-loss placements.
A strong, reliable continuation pattern, the bear flag is suitable for a variety of trading approaches. Apart from the most straightforward approach of simply shorting a stock, options offer another way to leverage the chart pattern. In fact, several options trading strategies for those just started out, such as long puts, are a perfect fit for the trading signals that bear flags represent.
Statistically, the pattern is reliable – with an oft-quoted success rate of 67%. However, it is important to note that this figure holds true for bear flags printed in a clear downtrend – bear flags that occur during range-bound trading or uptrends are far less reliable.
Confirmation is key when trading with chart patterns. Not all bear flags are legitimate – so while they might seem like the simplest chart pattern of all, you will have to actually dig deep and find confirmation via volume and other factors.
Along with that, flags that exhibit longer consolidation periods are less reliable – and so are flags where the consolidation period manages to “climb up” to a third or more of the preceding flagpole. Bear flags where the consolidation period reaches more than 50% of the flagpole’s length should be avoided at all costs.
Bear Flag vs. Bull Flag
Bear flags and bull flags are two sides of the same coin. Both of these variations represent continuation patterns – signals that the thus-prevailing trend will continue.
It’s useful to think of the two as mirror images of one another. In a bear flag, a sudden drop in price is followed by a short consolidation period, followed by the price dropping even further. In a bull flag, a large increase in price forms the flagpole, which is followed by a downward-sloping consolidation period, after which further increases in price happen.
The key difference is that bullish flags signal that an uptrend will continue. Just like with their bearish counterpart, it is important to note that these chart patterns only give reliable signals when they occur during clear trends. Bearish flags are only reliable in downtrends – bullish flags are only reliable in uptrends.
A flag occurring during an opposite trend can be a sign of reversal – unfortunately, those occurrences do not produce reliable signals. More often than not, something like a bullish flag during a downtrend is a sign of indecision – a good time to employ a neutral strategy like a box spread.
So, there you go – if you understand bearish flags, you also understand bullish flags. There are no major differences between the two, apart from the fact that bull flags lead to a 1% greater price moves on average when compared to their bearish counterparts.
Bear Flag vs. Bear Pennant
The bear pennant is the bear flag’s closest relative out of all the chart patterns. The two patterns give the same signal – bearish continuation, and they’re so similar that the untrained eye might easily see little to no difference between them.
In the image above you can see an idealized representation of the bear pennant. While it is strikingly similar to a flag, you’ve probably noticed the first point of difference – the shape that the price action forms after the “flagpole”
While flag patterns form…well, flags, with parallel support and resistance lines, pennants have sloping support and resistance lines that eventually converge. This consolidation period is also typically slightly longer in duration when compared to that of flag patterns.
Another major difference exists between bear flags and bear pennants – and that is their success rate. While bear flags have a success rate of 67%, bear pennants are far less reliable – with a success rate of only 55%.
Conclusion
The bear flag is an essential chart pattern – simple, frequent, and easy to spot. It boasts a high reliability rating, offers simple entry and exit points, and usually leads to significant price action.
All of this makes it a significant trading signal – but even more than that, it makes this chart pattern a perfect “training” tool for beginners to use and get more acquainted with chart patterns and trading.
It can be a mainstay in your arsenal and a reliable source of opportunities – but only if you take the time to absorb all the fine points and details that come along with it.
Bear Flag Pattern: FAQs
Is a Bear Flag a Bullish Chart Pattern?
No – a bear flag is a bearish continuation chart pattern, suggesting that a downtrend will continue
What is a Bearish Flag in a Downtrend?
When observed in a downtrend, a bearish flag is a very strong indicator that prices will continue dropping.
What Happens After a Bear Flag Appears?
After a bear flag appears, the consolidation period comes to an end and bearish price action sends the price even more downward. However, this is in case the chart pattern is confirmed – various other scenarios, such as failed breakouts, a return to range-bound trading, or even a reversal into an uptrend can occur.
How Long Can a Bear Flag Last?
Bear flags can form over a period of several days up to several weeks – however, the chart is significantly more reliable on shorter timeframes.
How Accurate or Successful Are Bear Flag Chart Patterns?
Bear flag patterns printed during clear downtrends have a success rate of around 67%.