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What is our definition of a flag? A flag is a gradual increasing of prices over time, after a decline. In this case, a continuation pattern for a further decline in the market.
We have a rounded top, established with the top of this bar, the top of this bar, and the top of this bar. It’s a fairly broad rounded top here. We have 6 bars here whose tops are very close to a nice rounded pattern.
Then prices declined, and they formed a flag, which is a gradual increase of prices over time. Not particularly strong increase in prices, but just a gradual increase in prices after this large decline here.
That gave us a clue – not only this rounded top, but this flag pattern gave us a clue that prices would continue to go to the down-side. And they did. Again, we come into a pattern in which there is a gradual and steady increase in prices, forming another flag.
Flags generally are a continuation pattern. They don’t have to be exactly at the highs of these bars, or the lows of these bars. What you are trying to do is pick up the pattern, to understand the pattern. After this pattern was established, that there was a gradual increase in prices, you would have had an extremely high probability that prices would continue this down-trend again. And they did.
Today, we had somewhat of a reversal day. In other words, we had an extremely strong up day, in which we had high volume, and high prices increased dramatically. In fact, the Dow Jones Industrial was up 201 points. Generally, a strong upthrust in prices like this indicates a strong market, and perhaps a continuation of an up-trend.
We have had an up-trend since around March 10. We had an extremely strong up day here. You can think of these extremely strong up-days with huge price movements as something like an energy blast, or fueling your car with premium fuel, really helping the market to blast off.
When we had that day, what we wanted to look for was a gradual decline of prices from that strong up-trend. When you have a strong price increase like that, in any stock or any indices, there are always people who are willing to sell their stocks at the high of that large up day.
Over the next couple of days, what we do is we watch the prices very closely, to see if a flag pattern will be forming. In fact, it did. Again, these do not have to be exact. What you’re looking for is a general pattern of slowly declining prices over time. That’s exactly what happened. These were a bit wider than usual, but that is to be expected at a market bottom.
This is really a market bottom, here. Prices did actually increase, pull back again, form another flag pattern – increase, form a tighter flag pattern, and break through that. It still established a higher low, and then increases in prices came again. Each time a price increase of a day or 2 or 3 days in a row was established, they had a slow, gradual pull-back, before prices continued again.
Eventually, as you start to develop your eyesight, your technical eyesight for these types of patterns – you will be able to pick them up very quickly. You will be able to see flags and patterns. Once you can see these, this the simplest form of technical analysis that really works. These types of flag patterns are the easiest to recognize forms of continuation patterns in the market.
Where we are right now – we have a very strong up day today, on pretty good volume. We are going to be hoping that it will continue to increase in price. However, what we are looking for, to establish long positions, is a gradual pull back in prices. Just like they did here, or here, or here. We’re looking for those gradual pull back in prices, so we can establish a long position.
Let’s go back a little bit further, and see this in other types of markets. Going back to July of 2007, you can see that we established what was to be a very large up-trend in the market. We had a huge run-up in prices here. We had a flag. You can begin to see these flag patterns develop.
Once you begin to see a number of these flag patterns, it’s a pretty safe idea, as long as you have higher lows, to begin establishing long positions in this area – if that was the type of trading that you wanted to do. You can see that almost all the way up, these flags were established. Once the flag was broken through, a continuation of the up-trend continued.
This pattern was a little bit different. It was just a sideways pattern. However, it is still considered a flag pattern. You can see that all of the patterns differ just a little bit. Some are extremely gradual, like this one. Some are sideways, like this one. Some are pretty deep, like this one. Some are a little bit deeper. This one was fairly short and narrow.
This one was very much deeper. In fact, it was the beginning of a sign that maybe, there was some trouble in the market, because of this rounding top.
Markets do not die very soon. There was, because of this rounding top here, and almost the breaking of this lower high here – you could have began, at that time, to start to look for signs of deterioration in the market.
Here’s another rounding top, and another. Rounding tops don’t necessarily mean that the market will decline, right after a rounding top. It is a way for us to determine the probability of a future price movement. If prices had broken below the prior lows of these, and each time it broke below these prior lows, you would have a more established down trend in place. But these rounding tops, every time the market moved up a little bit higher, was a warning that perhaps something was happening in the market, and prices were dropping dramatically.