How to Trade a Bear Flag

Here’s how to trade a bear flag setup

Bear flag patterns are one of the best chart patterns you can trade in a bear market and so let’s talk about how to trade a bear flag pattern.

Just in case you don’t know what a bear flag pattern is, it is basically a pause in a downward price trend that looks like a little flag on a on a flag pole, but on the bottom of the flag pole, and still flapping in the wind! Essentially you have it to where prices are dropping hard (that’s the flagpole), then they settle down and bounce around in a narrow range (that’s the flag part), before continuing to fall again – that’s your confirmation of the pattern. Traders watch for this pattern because it’s often a signal that the downward move isn’t done yet.

How the bear flag sets up:

Let’s take Floor & Decor (FND). A stock in the discretionary sector, getting hit pretty hard by the ongoing tariff trade war between the United States and China. The chart is setting up for a another leg lower as you can see here:

You have three important elements to this trade setup that includes a bear flag:

• Bear flag setting up in the short-term.
• Declining resistance or downward trend on the short-term offering additional resistance (bonus).
• Bear flag that confirmed, though this stock will be very sensitive to trade war news.

Having multiple layers of resistance above what would be an ideal stop-loss is also important. Placing the stop-loss above the April 9th highs is a large one relative to the entry price, which means to get a 2:1 return on the trade setup would require an $18 drop in the price of the stock, and would need to be able to reach $51/share to justify the trade setup. So there’s no way I’m doing that. I’d be more inclined to use the 20-day moving average to essentially work as a trailing stop per se. A move above the 20-day moving average and I would cover my short setup. That also helps tor reduce the risk substantially, plus the stock has a history of price rejection at the 20-day MA.

Using the moving averages for risk management

When it comes to using  moving averages for stop-loss placement, and in this case the 20-day moving average, I use the previous day’s reading, because the current day hasn’t been established yet and subject to change, plus if the stock starts to move against me, it is difficult to know where exactly that stop-loss will be placed at. Thus, I use the previous day’s reading to place my stop just above.

Again, I would like to use the April ninth highs, but that is simply too much to justify that kind of counter move.

My target price for trading the bear flag pattern

Ideally I would like to see this one dip below the the $60 range and hit the bottom end of that target area. If so there is about $12/share of downside for the trade setup, and with the ideal entry price at $71, that gives it about a 2:1 reward-to-risk ratio which allows me to justify this trade.

At the time of this post, I don’t know how this trade ultimately works out, I suppose, in the future, you could readily figure that one out. And if you find that it doesn’t play out the way the trade setup would hope for it to, doesn’t mean that technical analysis doesn’t work, it just means that price didn’t playout the way the chart suggested it would – and that is the essence of technical analysis, as it is here to provide an edge, a probability, but not a certainty. We call Keven Durant and Steph Curry excellent 3-point shooters, and they only convert on +40% of their shot attempts, so just because it doesn’t work all the time, doesn’t mean it doesn’t work.

And there you have it the essence of a bear flag pattern and how I trade them.

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