Flags and Pennants
Imagine that you must climb 10 flights of stairs as quickly as possible. You dash up the first five flights of stairs, and then stop to catch your breath. After this short pause, you resume bounding up the staircase toward the tenth floor.
Are we preparing for the Olympics or a triathlon? No, this type of behavior actually relates to a trading phenomenon. It’s not unusual for the exchange rate of a currency pair to race higher, then pause, and then continue to climb. Similarly, we often see the price fall rapidly, then consolidate, and then continue its descent.
This period of “rest” is called a consolidation. We say that a currency pair (or stock, or commodity) consolidates its gains (or losses) before moving on. A consolidation that indicates that the exchange rate will resume moving in its previous direction is called a continuation pattern.
Flags and pennants are short-term continuation patterns; after the formation of one of these patterns, the exchange rate has a tendency to continue moving in the same direction as it was prior to the consolidation. These patterns are generally found on short-term or intraday charts.
In the case of a flag or a pennant, the initial move is a sudden, sharp directional thrust. It doesn’t matter if the move is an advance or a decline, what matters is the velocity of the move. This sharp burst creates a long candle or a series of long candles on our short-term chart, and is referred to as a flagpole. If the movement ...