How to Trade a Failed Bear Flag

A failed bear flag turns into a bullish pattern instead of a bearish one. When learning about flags, a bear flag is always a bearish continuation pattern. So you’re expecting a downturn in a stock. However, patterns break down all the time. As a result, when a bear flag fails, you buy the move up instead of selling into a downturn. Because it turns bullish instead.

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What Is a Failed Bear Flag?

One of the best patterns to look for in technical trading is either a bull or bear flag.  This is one of the first patterns we learn and is considered the most reliable. However, if misidentified can lead to big losses.  Today, we’ll look at the pattern then do a post mortem on when a bear flag is wrongly identified and what happens when this failed bear flag pattern occurs. 

Here is the classic view of the bear flag.

Failed Bear Flag
  1. A bear flag is a continuation pattern in technical analysis
  2. The ‘flagpole’ is the trend preceding the ’flag’
  3. The ‘flag’ is a support level and highlights the consolidation after a trend
  4. Bear flag suggests (but doesn’t guarantee) that the previous downtrend will continue
  5. The flagpole’s height projected from the breakout level will be the proportionate target to close the position

In action we want to see something like this:

Failed Bear Flag

It’s rarely that pretty or easy. When we look at these patterns, there are some specifics to keep in mind, and these help us make better choices and prevent big losses. 

Specifics to Keep in Mind

  1. When bear flag trading, in order to manage risk, set a stop loss or failure level above the upper level of resistance (This is the best way to prevent a failed bear flag from biting you.)
  2. If the flag portion’s retracement becomes higher than 50%, it is not a flag pattern. Ideally, we want to see a 38% or less retracement.
  3. Use volume patterns to confirm bear flag price patterns. When there is rising volume going into the flagpole followed by declining volume going into the flag and decreased volume during the flag, it helps to validate the pattern and can indicate increased enthusiasm on the sell-side for the asset. Meaning that overall market momentum is negative, furthering the assumption that this preceding downtrend will continue.
Increased Volume

A Failed Bear Flag Pattern Post Mortem

Let’s assume we see the following; it appears to have potential:

Potential Bear Flag

We have some slightly increased volume prior to a pole and then the volume is decreasing. The flag generally moving back up as we would expect for a bear flag, and we will have a similar decrease (the size of the flag’s pole) that we can profit on. But this is the result.

Failed Bear Flag

What Are the Key Factors of a Failed Bear Flag Pattern?

  1. No closes occurred below the blue lower support level of a bear flag which signals that buyers were still interested in buying the asset at this price.
  2. During the flag phase, the volume was constantly decreasing but not low (for 7 days). Signaling that the bears never controlled the market nor could they drive the price lower. 
  3. The flag’s upper resistance line had a breakout on the third day. This was our first major indicator, and if it held was already a failed pattern.
  4. The volume increased with the second break of the pattern above our upper bear flag level and signaled that the bulls were back in control, leaving the bears behind.

There are a few takeaways that we can gain from this example. 

  • If we have set our stop losses correctly, we can prevent the big losses from occurring. To not do so is at our peril.
  • We want to see lower demand not decreasing demand, during the flag portion of the pattern.
  • If we see a retest of prior price levels, we’re concerned.
  • As the volume increases who’s in control? If bulls, then you need to close or never open in the first place.

How to Trade Failed Bear Flags

Bear flags AND failed bear flag patterns are useful to recognize as they will be both robust and reliable indicators. If you can identify both, you’ll make better, more profitable trades and prevent accidents. If you see that a pattern doesn’t result as expected, don’t fall into a trap. It’ll either be confirmed or unconfirmed, and you hold it as unconfirmed till it is confirmed

You can still profit from this information by looking for a potential break out in the opposite direction. If there’s a pattern failure, take a step back and see if you are looking too closely and that maybe this is just part of a larger pattern. 

Look for the two features of a failure:

  • Is the volume decreasing or decreased?
  • Has the upper bound been tested?

If you see a potential breakout, look at the volume to help confirm this breakout.  Look for high volume on the breakout because then your bear flag has failed. If the volume is still low, then keep watching.

Additionally, when we see a failed pattern, we can check it against the Donchian Channel indicator (DNC).  You can add a DNC to your intraday chart (assuming between 1hr and 4hr charts) and set the input at 55.  If the price is close to or touching the top DNC line, then you likely have a break out forming, not a bear flag. 

If you can incorporate these procedures into your bear flag trading, you will be ahead of the game. One final thing to look out for are the dark pool trading activity for that particular instrument. A lot of times a stock will reverse and it’s because the dark pools have placed a large order.

As always, never trade more than you are comfortable with, and good luck with all your trades. 

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