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Flag Tutorial

Introduction to Flag-Trader

Have you ever traded a stock where you were in a winning position? Have you seen your paper profits start to increase as the stock rose in your favour? What did you do? Did you have a plan of how to take your profits, or did you stay in? Did you stay in too long? Did you stay in as the stock started to fall? Did you stay in until your profits were all wiped out and you now had a loss-making situation? Did your winner end up being a loser?!

Most people who have ever invested in the markets have been through this type of situation...on multiple occasions!

Why is it that traders stay in a position too long? Why is it that traders don't take their profits when the signs are that the stock is about to reverse?

Well, I can only really go by the countless interviews I've conducted with traders and investors, plus my own early experiences. The fact is that most people don't know how to find stocks! So, when they suddenly find themselves in a winning situation, they hang on for dear life, as if it's the only opportunity they're ever going to find! Does that ring a bell? Because, if you did know how to find good opportunities on a regular basis, then you wouldn't need to hang around in an existing position if all the signs said "sell"!

There's another key. That is to have a clearly defined Trading Plan. Most traders have no idea what a trading plan is. They go to seminars and read books, but they are never taught how to enter or exit a particular trade. A Trading Plan outlines your entry and exit points ahead of time so you know exactly what to do in any circumstances ahead of time. In other words, every trade has a business plan attached to it.

So, we need to address two major areas in this e-book:

  1. how to find stocks
  2. how to create a Trading Plan

Benefits of this Method

To clarify why the methodology you're about to learn is so important, here are some compelling reasons to make this a serious part of your trading arsenal:

  1. never let winning position turn into a loser again
  2. have the confidence to find new opportunities almost at will
  3. ensure discipline in the Trading Plan methodology
  4. specialise in trading a proven chart pattern
  5. simplicity of the method ensures no confusion and no analysis paralysis
  6. only enter into trades when the trend is proven and reconfirmed by the pattern

When people have gone through my workshops, they know how to create a Trading Plan and they know how to find the stocks they want to trade. We don't regurgitate things they could read in a book unless it's central to the Trading Plan or to recognising the precise patterns we like to trade.

In a short space of time that's exactly what we're going to accomplish here in the next few pages.

The first step is to identify what types of stocks we're looking to trade.

The typical problems faced by traders include:

  • overwhelming amounts of information
  • complexity of trading methods
  • lack of confidence in finding new opportunities
  • indiscipline owing to complexity and lack of confidence
  • poor timing of trades
  • time constraints to learn and then implement trades

In this booklet, you will see for yourself how to create a proper Trading Plan and how to specialise in a proven chart pattern within the overall context of a trend. By following the method, you'll discover that time no longer is a constraint. Overwhelm is eliminated and the Trading Plan is simple to execute, thereby helping your timing. Combined with the Flag-Trader product, your confidence will increase as you start finding opportunities with monotonous regularity.

The first step is to identify what types of stocks we're looking to trade.

Flag Patterns

My favourite chart pattern is a flag pattern. This occurs after a thrusting surge (the flagpole) then consolidates (to form the actual flag). The thrust can occur in either an upwards (bullish) or downwards (bearish) direction.

A Flag occurs during a persistent and dominant trend and temporarily interrupts that trend before resuming it.

The flag itself consists of the price pattern rebounding off 2 parallel interim trendlines before breaking out in the direction of the dominant trend.

Bull Flag:

With bull flags, our entry is a buy order and our stop loss is a sell order. We anticipate a rising stock price.

So here we can see that we have the makings of a trading plan:

We enter our buy order at either point A or B.

Point A is at the level of the top of the flag. As such it is the most conservative entry point, because it is where the stock is making new highs. You must make sure that volume is increasing as the new high is made. Increasing volume means there is conviction behind the move, which makes it more likely to be sustainable.

Point B is where the stock breaks out of the flag itself. This is more aggressive than Point A, and again requires increasing trading volume to demonstrate conviction in the move.

If the entry is activated then we need a stop loss. Point C is the level where, if we're already in the trade, we'd exit with a small loss.

This is your basic trading plan for a Bull Flag, within the context of an upward trend.

Bear Flag:

With bear flags, our entry is a sell (short) order and our stop loss is a buy order to close the position. We anticipate a falling stock price.

We enter our sell (short) order at either point A or B.

Point A is at the level of the bottom of the flag. As such it is the most conservative entry point, because it is where the stock is making new lows. You must make sure that volume is increasing as the new low is made. Increasing volume means there is conviction behind the move, which makes it more likely to be sustainable.

Point B is where the stock breaks out of the flag itself. This is more aggressive than Point A, and again requires increasing trading volume to demonstrate conviction in the move.

If the entry is activated then we need a stop loss. Point C is the level where, if we're already in the trade, we'd exit with a small loss.

This is your basic trading plan for a Bear Flag, within the context of a downward trend.

Let's look at an example of each:

Chart 7: Trendlines

Chart 8: Bear Flag

Flags within the context of a Trend

Now, what if I then said to you, how about finding flags within the context of a trend? That means you can play the flag, knowing that the trend is backing you up. Now we're beginning to add some backbone to our trading plan!

All we have to do is draw a trendline to see if the flag is forming within the context of a trend.

In the above two examples we can see that this is the case. The Bull Flag is within the context of a 2-month up trend and the Bear Flag is within the context of a 1-month down trend.

Chart 9: Bull Flag resolved to the upside

Chart 10: Bear Flag resolved to the downside

If the trendlines are broken then we would exit the long (Bull Flag) or short (Bear Flag) positions. Similarly, to enter into the long position, the price would need to rise above the top of the Bull Flag or break up through the upper flag trendline.

To enter the short position the price would need to fall below the bottom of the Bear Flag or break down through the lower flag trendline.

Do you see now how we can make simple rules regarding the trend and flag patterns in order to create a cohesive trading plan?

When a stock is trending, it typically does so in steps...or flags. Therefore, by identifying trending stocks, we're de facto going to find flags too.

The key now is how to find trending stocks and flag patterns at will. The problem many people have with trading a winning position is that they're scared they won't find one ever again. Therefore they stay in too long and eventually they end up forfeiting their losses. Does that sound at all familiar?!

Well the good news is that we have developed some sophisticated algorithms that find trending stocks, whether they're up or down.

Trending Stocks

We've all heard the expression "The Trend is your Friend". Well, although it's a little hackneyed now, the basic premise is true. If you can learn how to trade with a trend, and it's ludicrously simple to do so, then you are well on the way to trading consistently and successfully. The next step is to discover how to find trending stocks, and what particular patterns you need to trade.

What is a trend?

A trend can be defined in any way you desire, however, it helps to have a clear definition in your mind so you can easily interpret when a trend is occurring.

Uptrend

An uptrend can be described as a sequence of higher lows in conjunction with higher highs.

Downtrend

A downtrend can be described as a sequence of lower highs in conjunction with lower lows.

Some people define an uptrend as when the closing price is above the moving average (of a specific period), and a downtrend when the closing price is below the specific moving average.

I don't use moving averages of price movement to define trend, nor to source trending stocks. There are inherent flaws with using moving averages, which we'll discuss below.

In my workshops I ask my delegates how they find trending stocks, and the two most common answers I hear relate to moving averages and fundamental filters. From those two answers I already know that the person concerned doesn't find trending stocks, purely because moving averages and fundamental filters don't find trending stocks!

So first things first, let's identify some trending stocks, and clarify why they're trending. For this, we'll need the use of real price charts.

Chart 1: an up-trending stock

As you can see, the stock is rising and appears to keep bouncing off the imaginary trendline at the points B. This trendline is providing support for the stock. Typically we expect volume to rise as the price hits the trendline and bounces off it, confirming the supporting action. Notice that with an uptrend, we draw the trendline to join up the lows.

Sooner or later the uptrend has to be broken and the stock will retrace downwards. The beauty of using a trendline is that when the price breaks through it, we can define the trend as being over.

So far so good. Let's now look at a down-trending stock.

Chart 2: a down-trending stock

Here is the opposite case. The stock is falling and appears to keep bouncing off the imaginary trendline at the points B. This trendline is providing resistance for the stock. Typically we expect volume to rise as the price hits the trendline and bounces off it, confirming the resistance action. Notice that with a downtrend, we draw the trendline to join up the highs.

Sooner or later the downtrend has to be broken and the stock will retrace upwards. By using a trendline we know that when the price breaks through it, we can define the trend as being over.

If this sounds easy, the reason is because it is easy! If you're looking for something more complex, then I'll show you moving averages and why they don't work for defining trends. You want your interpretations of trend to be made easily, because it helps your decision making process when it comes to actual trading. If your interpretation of a chart isn't clear, your trading will be equally as unclear, which will only lead to inconsistent, bad and unsuccessful trading.

The Myth of Moving Averages

Moving Averages are the most widely known and used technical indicators. A moving average is simply the average closing price of a period of bars on a price chart. On a daily chart, a 20 period moving average is the average of the last 20 days prices. Tomorrow's moving average will include what happened today (but not tomorrow) and similarly, today's moving average includes what happened yesterday (but not today). Moving Averages are useful for the way in which they smooth price action and they are perceived by many to be good indicators of trend.

The most popular way of using moving averages is to have one short term and one longer term. When the short moving average rises up through the longer term moving average, this is a bullish signal. When the short term moving averages falls down through the longer term moving average, then this is seen as a bearish sign.

The problem is that this method is only remotely relevant with trending stocks. And if we can't readily find trending stocks, then there's no merit in it whatsoever. The other problem with it is that by the time the short MA crosses the longer MA, the stock price may well have plummeted or rocketed ahead of time. In other words, a moving average is a lagging indicator, and if the lag is too long, then the stock moves ahead without you. If the lag is too short, then there are no smoothing benefits to using the moving averages at all.

So, what if the stock is rangebound, or zig-zagging all over the place? Well, then moving averages aren't going to be any use to you.7

Chart 3: moving averages example

In the above chart, using moving average crossovers, the sell signal occurs a full $40.00 below the high of the stock. That's not exactly very efficient, and in the meantime the stock has been up and down in vicious swings that would send us diving for the Pepto-Bismol!

So, moving averages are best used when the security is trending. See below how confusing the signals become when the stock is rangebound.

Chart 4: moving averages double crossovers

Each "D" stands for "Double Crossover" whereby the moving average sends a long and short signal (or short then long signal) in quick succession, resulting in losses to our account. If this happens continually, then our accounts can be eroded pretty fast! Do you now see how moving averages could be something of a myth?

Notice below that we're back into a trending situation, this time the trend is downward, there are fewer double crossovers and the position is a little clearer. But even here, (a) we still have those confusing double crossovers and (b) we still need to understand how to find trending stocks.

Chart 5: moving averages on a trending stock

Trendlines

The easiest way to identify a trend is if you can draw a trendline. Trendlines are far more reliable and simple to use than moving averages.

With an uptrend, the easiest way to trade is if you wait for the trendline to be hit and the price bar to bounce upwards off it, continuing the trend.

With a downtrend, the easiest way to trade is if you wait for the trendline to be hit and the price bar to bounce downwards off it, continuing the trend.

A break of the trendline, particularly with rising volume, may signify the end of that trend.

Chart 6: Trendlines

If the trendline is broken, particularly if it's broken with an increase in trading volume, then we know the trend is over and we can go and play another stock. The advantage is that we exit almost immediately and the rule is very straightforward. With a moving average we may have to wait several more days until the lines cross over, and by that time we could be sitting on significant losses.

Trending stocks tend to move in steps. These steps involve thrusting moves followed by consolidation. These moves can be referred to as steps, or in some cases, flags. A flag is distinguished by the significant thrusting move prior to the flag forming.

Finding Flags and Trending Stocks

We obviously can't disclose the algorithms we created to find these types of stocks, but I can tell you that they are neither based on fundamental criteria nor moving averages of price action.

What I can tell you is that our algorithms discover trending stocks relentlessly, every day, every week, every month and every year. All you need to do is choose the one you like the most, subject to your own filter criteria. Choose the best flag pattern, or simply play the trendline itself. It's up to you.

When the markets are generally trending down, there are likely to be few up-trending stocks and vice versa. Typically, whatever the general trend of the market, you want to trade in the same direction until the trendline is broken. By trading in this way, you're being responsive to a potential change in direction, but you're not trading so tight that you'd be whipsawed out of a profitable position.

Intelligent Stops

On the subject of stop placement, I've heard many speakers who spout the expression "Use tight stops". Tight stops mean, in the real world, that you'll be stopped out because your order can be seen in the market. Stop orders need to be placed intelligently, not too tightly. If your sell stop is only a cent below you buy order, then it's highly likely you'll be stopped out, hence making both a loss on the stock and commissions.

Flag-Trader™

Flag-Trader finds trending stocks, up or down, over multiple time frames. We already appreciate that you'll be more successful when you trade trending stocks. We already appreciate that you'll be able to create a trading plan for those trending stocks and flag patterns. Now all you need to get started is Flag-Trader, so you can find those flags and trending stocks in the first place!

To get started now, click here for access to Flag-Trader, where you can source flag stocks and filter for those that suit your trading aspirations the best. It's ultimately your choice, but we give you the best possible head start. History demonstrates that trading with the trend together with specific chart patterns, yields investors the highest returns. Now it's your turn to take this opportunity and start trading with the trend and see your account grow.

References

  • Guy Cohen
  • FlagTrader
  • Nicolas Darvas was a world famous dancer, self-taught investor and well-known author.
  • Box Theory - A trading strategy that was developed in 1956 by former ballroom dancer Nicolas Darvas. Darvas' trading technique involved buying into stocks that were trading at new 52-week highs with correspondingly high volumes.