November 17, 2008

Flag Pattern

By Planet Wealth

A common pattern we are seeing alot of in the trading room of late is a Flag.

The flagpole will usually develop because of positive news such as favourable company earnings announcements: basically news that will spike the price of a share higher.

After the price of a stock has risen so quickly and the excitement of the positive news subsides, the flag develops because fewer buyers are willing to pay the high price that was commanded just a few days before, but at the same time, sellers are unwilling to sell below a lower support limit. As the flag develops, the volume will tend to decrease. This is basically a consolidation period.

Once the stock breaks out of this formation, the target price is the height of the flagpole. It’s vital to see the price breakout on higher volume. Essentially, the flagpole formation is a break in a larger uptrend, the price might have gotten ahead of itself therefore needs a break, or consolidates before continuing the upward trend.

Looking at BHP, we can see it is forming a potential Flag right now on the Daily chart. If we see a break out on higher volume there is the potential for the stock to head to $36.50, which is also a major weekly support.

(click on image to enlarge)