In this article, we will be sharing our top-down analysis on a bullish flag pattern that brought us 60 pips on NZDJPY.
The flag pattern is a very common pattern that appears in the Forex market. When traded correctly, the reward far outweighs the risk. This setup we took in our Trading Floor is a prime example of that.
Typically, there are 3 main parts to a flag pattern. They are: the pole, the flag and the breakout.
When identifying the pole, you want to look for strong impulses that are obvious to spot. In this example, the pole can be identified at (1).
The next thing we want to look out for is the flag itself. The flag (2) is established in the form of consolidation within a channel. Price tends to bounce around in the channel before breaking out of the pattern.
After the sideways price action completes, a breakout is inevitable. In this trade, we bagged a cool 60 pips.
Now that we have correctly identified a potential flag pattern, it’s time to predetermine our stop loss and take profit level. For bullish flag patterns such as this one, conventional stops will have to go below the flag. However, some traders prefer conservative stops, having their stop loss below the previous low, at the expense of a lower risk/reward ratio. Risk management is subjective to each trader so you will have to place your stops wherever your risk/reward rules allow you.
We prefer to have a risk/reward of more than 3. This means we will be risking 1R to make 3R. In this setup, our stop loss was 15 pips below our entry and our target was 60 pips. This gave us a potential risk/reward of 4, which is of course more desirable than 3.
The entry for this trade was located at the bottom trendline of this channel. How did we know that price was going to bounce off this level and eventually break out? We didn’t. There was always a possibility that price would not respect the channel and break out towards the downside. There was also the possibility that price would continue bouncing around this channel before eventually stopping us out.
Now that we have determined our entry and stop loss, it’s time to establish our take profit level. Conventional targets are located at the top of the pole. However, we were looking for a potential bullish continuation. As such, we had a more aggressive target, which was above the top of the pole.
The reality of trading is that we have to take predetermined risks, and in this case, the risk we took paid off well. Price reacted well with our entry, before reversing towards the upside. You can see how price paused it’s bullish momentum near the top of the pole. This suggests that many other traders, who went long after the breakout, took profits off the table at that area. Price eventually resumed its bullish momentum and hit our target of 60 pips.
Flag patterns provide very reliable setups with the potential to reward you several times your risk. With a keen eye, you’ll realize that flags appear all the time across all timeframes and anyone with patience can trade this simple pattern profitably.