Flags and Pennant Forex Strategy
Hey, traders. Welcome to video 11 of the Advanced Forex Strategies Course. In this video, we’re looking at the flag and pennant strategy. Plus, we’re going to look at a few other insights, which I think you can apply to all these other strategies and give you a little bit better idea of what it takes to be a successful trader. These patterns will occur on all timeframes. Brought to you by Investoo.com.
So, trend trading, as I always say, is where the money is. Flags and pennants breakouts provide a way for you to get in on the next trending move. As always, our risk will be lower than our potential reward. You’re going to see these types of patterns on all time frames. Flags are going to be our focused. Pennants are very similar and traded in the exact same way, but flags occur more often.
So, trade in the direction of the trend, which is the direction of the flag breakout. Flags are called a continuation pattern, since they slightly more often than not break out in the direction of the prevailing trend. So, if you have a short move down, we’ll have a flag, which we’ll learn about in a second. Down flag . . . We expect it to drop down about 55 to 60% of the time. Quite a bit of the time though, 40 to 45% is going to go the other way.
So, make no assumptions. A breakout in the opposite direction of the trend is also tradable. With this strategy, we can set and forget. No touchy- touchy. Let math do the work. Only trade neat flags. If in doubt, use the mini channel breakout strategy we covered in video three.
An upright flag has two parts. The first is a sharp upward move, which we call the flagpole, followed by a very tight consolidation that is angled slightly lower or sideways. Very rarely, it is angled slightly up. We draw lines along the highs and lows of the consolidation. Consolidation should be at least four bars and the breakout level neatly defined. I’ll show you exactly what I mean by that when we look at the videos or the examples.
When the price moves above the confines of the lines, enter long. Place a stop just under the pattern. Target is the height of the flagpole added to the bottom of the flag. Don’t use extremes in price. Once again, we’ve gone over this in prior videos. It’s much better to get out of a trade than to be a bit too aggressive and miss your target by a few pips.
Only measure the sharp moves, and don’t measure slow-downs before the consolidation. I’ll show you exactly what I mean by that in the examples. When in doubt, use 1.6 times your risk as your target. If you take multiple positions, exit one position at 1.6 times your risk and the other position at the target. This is a fusion, I guess you could say, of the mini channel breakout strategy, which is similar but a couple differences. So, this is taking some of the elements of that, which is a strategy I like, and applying them to this.
Risk must be kept below 1%, regardless of how many entries you take, even if you’re using the multiple targets or stops. Keep the risk on all the positions on that setup below 1%. In the alternative case, if we have this upward flag but the price drops below the flag, we enter short. Stop goes above the pattern. Be even more conservative with the target, since we’re going against the prior trend. We knock off approximately the height of the pattern.
An upside-down flag has two parts, once again. First is a sharp move down, which we call the flagpole, followed by a tight consolidation that is angled slightly higher or sideways. Very rarely will it be slanted down. Draw lines along the highs and lows of the consolidation. Consolidation should be at least four bars with a breakout level neatly defined. When the price moves below the confines of that flag, we enter short. Place a stop just above the pattern.
Same target. We’re using the height of the flagpole. Subtract it from the top of the flag. Don’t use extremes in price. You also have the option of using the 1.6 target, if you like. Risk must be kept below 1%. If the price rallies above the flag, we enter long. Stop goes below the pattern. We want to be conservative again, since we’re going against the prior move. We’re going to knock off a bit of that profit target.
So, I’ve chosen a few entries here on purpose. They’re not all that pretty, to be honest. I’ve chosen them for a reason, simply to tell you about a few other insights into trading. So, I’ve written something here. For all these strategies, the exact entry doesn’t matter. Over a great many trades, it is simply that you make more on . . . Oh, that got cut off . . . more on your winners than you do on your losers, and win about 45% of the time.
So, if you can win more than 45% of the time and make more on your winners than on your losers, it doesn’t matter if I say this is how I trade a flag pattern and someone else trades it slightly differently. The point is that as long as we have this, overall we’re going to end up being profitable. So, we have this flag here, a very sharp move down, followed by this consolidation. Now, I’ve used this one on purpose, simply because we have a high that’s defined by three bars here, and we have a fourth bar. So, we have at least a four-bar slowdown. We have a low that’s defined by the major low and also by these four bars here.
So, the first question a lot of traders will ask is, “Do I go short here? Or do I go short here?” What I’m trying to tell you is that it doesn’t really matter, because on some trades you’ll go short here, and if you do this trade 100 times in your career, this is going to work out. This is going to work out. Sometimes you’re going to lose on it. Sometimes you’re going to win on it. At the end of the day, it all comes out in the wash.
So, there is a potential entry here, where you could say, “All right. That pulled back.” But now, we have a consolidation. This is the flag. I’m going short. You go short right at this white line as this bar drops below it. You put your stop up here, just above the highs of the pattern, and you ride the momentum down. Or you could say, “No, this is the very low of the pattern. I’m going short here, putting my stop up here,” and ride it down.
So, in either case, this broke out, pulled back. You wouldn’t have been stopped out though, and we continue to the downside. So, this is a flag- type pattern, where we have a sharp move, it pauses for at least four bars. We do have defined entry points. By that, I mean you have at least a couple bars that highlight an entry point.
Now, we need to figure out our target. So, once again, as we’ve looked at in a few videos, this can be tricky. On the triangles video, I said don’t use extremes. I showed you how to do it. Here, we’re going to do the same thing. So, we have this sharp move higher. Now, technically once it gets here, we’re in free-fall. We’re not in free-fall yet. You can see, while we started up here, we pulled that quite a bit. This bar is where we start to notice a lot of downward movement. So, I’m using that, the actual start of that decline, where it’s relentless.
Down to here, can’t really pull back, and it comes back to this point. This, to me, this area tested multiple times. I like that as my target. I’m not going to use this extreme down here, because it wasn’t hit very often, bounced right away off of it. Whereas this area, it did bounce, but it came right back to it. So, this is a target that I like.
I can quickly compare, regardless of which entry point I used, whether it’s that one, I can see this is my risk for that trade, and my target is much bigger. Even if I enter down here. In that case, this is my risk from my stop to my entry point. So, that represents my risk, and my target is still bigger. So, the target goes from the top of the flag. So, we put it right at the top of the flag, and we can see our profit target would have been right down here, and we would have got out of that before this mess here. If not, we still would have been able to get out down here.
But, notice if I would have been extremely aggressive in my pricing of this or in my target, and said, “Okay. That’s how much we’re going to drop,” I would have been way off. Even though this came all the way onside and would have showed me a nice profit, I missed my target by a long shot. Be conservative. This is not looking at things in hindsight and saying, “Oh, I need to be conservative.” We need to be conservative all the time, because this sort of thing is going to happen a lot. If you’re too aggressive, you’re not going to hit your target.
I looked at one other one too, which is a bit ugly, a bit different structure. I want to highlight a few things here as well. We have this sharp move down. Once again, it hits this level multiple times. So, I don’t mind using that as my target. Let’s change the color of that. This one, a little more ugly since it’s not relentless selling. We kind of want to see that relentless momentum like what we saw here, where it’s just boom. But in this case, it’s still okay.
We can see there’s still overall selling. There’s no real buying going on. Then, we enter this pause at four bars, basically here. We don’t have any clearly defined breakout areas if we were just looking at this in real time. Basically it’s just slowed down, but we don’t have a flag yet.
As more bars develop, we can start to see, “Okay. Along the bottom here, I have a potential entry point based on the lows of these.” So, I can draw a trend line there. Along the highs, we also start to see this as well. We’re edging higher. Lows are edging up. So, here, we start to see a big longer- term flag. As we can see, this is much longer than four bars, but the flag develops over those higher numbers of bars.
We have a pop higher here, which I’ve highlighted and said, “Rising equals expected.” We are making slightly higher highs. We see this. We see this rising. So, I wouldn’t trade this breakout, even though it pops above these bars, simply because we’re almost expecting that the price is going to edge up a bit. If this pattern continues, that is going to occur. So, don’t trade that first one going against the prior move, simply because this is not a high probability trade.
Based on these prior moves, we know that these lows . . . sorry, these highs are creeping up. So, we don’t want to trade something that’s just potentially creeping up. On this type of flag, we would much rather see the break to the downside, as we do with most trend trades. We’d rather see it go in the trending direction. But, since we have a tendency here of the price creeping up, do not trade a breakout when the price is creeping up.
So, here, looking at this major decline from the high of the pattern. So, our target would have been down here. Not going to let me select. There we go. So, once again, we can quickly see if our risk is greater than or less than our reward. So, entry point would have been right about there, our stop just above that high, basically would have been the high of this box if I just move it down a little bit.
So, here’s our risk, from this point to our entry point. We can see our expected profit much bigger than that, so a good trade to take. Line that up. Get our target down here. So, if you want the actual numbers, we can look at that. So, we’re looking at about 30 pips of risk. We can see 301 there. That means 30.1 pips. Moving from the entry point down to our target, looking at about 46 pips of profit.
So, once again, a few insights here. Focus more on letting the winners run out to your targets. Like I’ve said in every video: no touchy-touchy. Just let the math do the work for you. That’s what matters over the long run, not whether you take this trade here or this trade here. Another thing I want you to think about is the tendency of the price action. We are seeing that the price is making slightly higher highs. So, when this edges above your trend line, we know that the price is making slightly higher highs. So, don’t trade that as a breakout, because we have a tendency already.
Whereas this, when this makes a lower low, that’s a slightly different tendency, and also we have a flag. So, we have downward momentum. So, we want to trade more the downside breakout in this case than trading this. Now, if this rockets up then pulls back, we might have some evidence to go long, but that is a different strategy, which we’re going to cover in future videos.
For right now, look at the tendency and say, “All right. We’ve just gone down. We’re slightly rising. So, if this just peaks above that trend line, that’s not a good trade to look for.” I would rather wait for this downside breakout, simply because it shows a different tendency. The price is making a lower low here, and I’d rather participate in the downside. Once again, be conservative with your targets. Measure it out. Look at just the strong moves, and it’s from the top of the pattern.
So, every trade has a stop and a target. We put those out right when we place the trade. Risk 1% or less of your account per trade. That way, even a string of losses won’t draw down your account. These take time to practice and spot and trade. They look easy, but there are lots of similar looking patterns that are a low probability. When in doubt, trade the mini channel breakout strategy in the direction of the trend only. So, go back, Look at that video if you don’t remember it.
Make sure there is a sharp move followed by a very tight consolidation or flag. If it doesn’t have the right look, don’t trade it like a flag. Trade in the breakout direction. Place stop just outside the pattern on the opposite side of the breakout. Target is based on the height of the flagpole. For an upside breakout, we add that height of the pole to the bottom of the flag. For a downside breakout, subtract the height of the pole from the top of the flag. I use that measuring tool on just trend lines. Makes it very easy to quickly see whether your risk is greater than your reward.
Be conservative. The reward will typically more than compensate for your risk. If taking a trade in the opposite direction of the trend, we didn’t look at that because we didn’t have any examples of it. But, if that occurs, reduce your target by about the height of the flag. So, whatever your stop is on the position, knock that off your target, which means in a lot of cases, it’s not going to be a worthwhile trade.
So, usually we want to be trading in the trending direction. We looked at that one example. We had the false breakout to the upside. We skipped it because there was a tendency for that price to be edging higher in that flag that was angled up. So, we also have an option to use a 1.6 times our risk. This is sort of a hybrid of the mini channel breakout strategy. So, if we’re holding multiple positions, you can get some out of that 1.6 and hold the rest for a target, for the full target, based on the pull.
Trading involves substantial risk of loss. Only trade with capital that you can afford to lose. Test out strategies before using them to make sure you are able to implement them and that they work for you. Until next time, happy trading.