Lessons from Oct 13 Morning Ideal Bear Flag

Oct 13, 2009: 3:06 PM CST

The morning session – continuing over from a pattern into yesterday’s close – gave us an excellent example of a bear flag that I’d like to show you as an educational reference on trading tactics and “Enhanced Flags.”  Let’s take a look:

We’re seeing a TradeStation chart of the 5-min SPY along with the 3/10 Oscillator and the TICK.

I must say this flag took me a bit by surprise thanks to the final push up into yesterday’s close, but that also serves as a reference of ‘real world’ trading.

The flag began with an initial impulse lower (“pole”) into the 1:30pm CST lows of Monday.  Impulses are impossible to predict in advance.

Then, a 45 degree angular retracement formed which allowed for the drawing of two trendlines as shown, as price retraced back to the confluence of the 20 and 50 period EMAs… setting up the “Flag” portion and triggering the trade entry for the pattern.

The ideal entry occurred just after the “Shooting Star” candle at 2:35pm CST as price had retraced upwards into the 61.8% Fibonacci retracement and the 50 period EMA – both expected to serve as overhead resistance if indeed this played out as a bear flag.

A stop-loss would be a minimum of 10 cents (1 @ES point) above the 61.8% retracement, which often serves as the ” Line in the Sand” between the maximum retracement of a successful vs unsuccessful flag pattern.  Aggressive traders might have even decided to place their stop above $108.00 which was the price high of the pole.

As for the Target, I like to take a 100% Fibonacci Price Extension/Projection (as shown in my prior post on “How to Project the Measured Move of a Bull Flag“) from the top of the Flag to project a minimum objective.  In this case, the minimum objective was $107.03… which as you see was quickly exceeded.

The next target might be a 138.2% “Fibonacci Extension” of the impulse (instead of 100%, which would be a perfect “measured move” of the impulse, a 138.2% extension is more in line with how the Fibonacci Extension tool is used) which came in at $106.76.  The absolute low of the day – and of the pattern – was $106.75.  Impressive.

Many traders like to exit positions at such targets and consider “flipping and reversing,” meaning to buy on any bounce off of a price target – that is an aggressive strategy.

The one caveat to note about this bull flag was the final “swing up” into yesterday’s close which was a red herring and may have led to some premature stop-losses being triggered for those who entered short expecting a Bear Flag to play out – otherwise, strict day-traders would have exited on the close.  Only swing traders who endured the pullback into the close could have taken full advantage of this bear flag.

An alternate way to anticipate the trade, or at least play off the price target, was to see the flag into yesterday’s close and note the downward action of the morning session and then short to play for the $107.03 price target.  In other words, expect the structure of the flag to carry down and drive price down to the expected target.

This is the kind of educational examples that take place each day in my subscriber “Idealized Trades” reports, which summarize the day’s action with “teaching moments” in addition to looking at how today’s structure might carry forth into opportunities into tomorrow’s intraday trading session.  Check out examples for more information on subscribing.

I’ll likely try to work this flag in as an “Enhanced Flag” example in my presentation “Best Trades to Take using Momentum and TICK” at the Las Vegas 2009 Trader’s Expo (register now!).

The more you see these patterns, the better you’ll be able to recognize and trade them effectively when they appear in real time.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

For other “flag” examples  information, see my previous post entitled “How to Trade a Bull Flag” or the section on “Bear/Bull Flags” at our Education Section.

7 Comments

7 Responses to “Lessons from Oct 13 Morning Ideal Bear Flag”

  1. pipercolt Says:

    nice eye on that one, but who would have thought it would have broken the lows

  2. Corey Rosenbloom, CMT Says:

    The morning gap was an early clue of the possibility, and the flag pattern was visible from yesterday's close (the end-of-day rally threw me off a bit) and the market is very overextended with bearish non-confirmations as mentioned in the prior “dual three push” post.

    Intraday it might have been hard to see but with a larger perspective – and it's still all odds and probabilities – one could have expected a break of yesterday's swing low.

  3. Spyder Says:

    Taking it one step further, a second flag developed after the downward pole and formed a similar looking pattern with momentum and tick lows. However this broke upwards strongly from abott 11:00 to 12:00 on your chart. To me the look of both is so similar that I would be hard pressed to predict the upward BO. Is it a flip of a coin or do you see more than I do here??

  4. Corey Rosenbloom, CMT Says:

    Good point, Spyder.

    At the time, I thought it would be a 4th wave pullback in anticipation of a 5th wave down in a sort of bear flag like you mentioned.

    One thing I've learned from experience is that it's rare – not impossible but rare – to get two simultaneous bear flags off of the same impulse. That's what would have occurred here, so the second flag was a lower probability than the first.

    Patterns aren't necessarily coin flips because they derive their edge from historical testing and from the fact that the target (fixed) is always lower than the stop-loss which gives a type of duality of edge. Most chart patterns are like this – it's not the accuracy of patterns that make money, it's the edge from the risk-reward that does (over time).

  5. Corey Rosenbloom, CMT Says:

    Good point, Spyder.

    At the time, I thought it would be a 4th wave pullback in anticipation of a 5th wave down in a sort of bear flag like you mentioned.

    One thing I've learned from experience is that it's rare – not impossible but rare – to get two simultaneous bear flags off of the same impulse. That's what would have occurred here, so the second flag was a lower probability than the first.

    Patterns aren't necessarily coin flips because they derive their edge from historical testing and from the fact that the target (fixed) is always lower than the stop-loss which gives a type of duality of edge. Most chart patterns are like this – it's not the accuracy of patterns that make money, it's the edge from the risk-reward that does (over time).

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