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Bull Flags
Technically speaking, a bull flag is a sharp, strong volume rally on
a positive fundamental development, several days of sideways to
lower price action on much weaker volume followed by a second, sharp
rally to new highs on strong volume.
Why Does It Happen?
Bulls flags are favored among technical traders because
they almost always lead to large and predicable price moves.
Like all continuation patterns, bull flags represent little more
than a brief lull in a larger move higher. Indeed, in many
cases the flag pattern will actually take shape in the middle of
the ultimate move higher. Bull flags occur because stocks
rarely move higher in a straight line for an extended period,
instead, the move higher is broken up by brief periods where
traders "catch their breath". The first part of
the flag pattern is often called the flagpole or mast.
During this phase the stock price skyrockets to a reaction high (a) on some positive fundamental development.
Very often this will be the unveiling of a new product, a
favorable legal resolution or positive earnings surprise but the
change in price is near vertical as would be sellers are
overwhelmed by new buyers caught-up in the euphoria of the
moment. As the stock soars speculators that were smart
enough to have purchased the stock at lower levels begin
selling. At this point the second phase or flag
portion of the bull flag begins. Because the flow of news
and investor sentiment is overwhelming positive, most of the stock
sold by speculators is easily absorbed in the beginning but as
time passes fewer investors seem willing to pay the current
price. Slowly, the stock price begins to falter on
dramatically reduced volume. The descent is slow because
bullish sentiment is still very strong. After several days
of minor weakness, a rally begins and a minor low is set (b).
Sensing an opportune time to enter new positions buyers begin to
return, pushing the stock very near the most recent high but
because volume is light this rally is easily rebuffed and a
slightly lower high (c) is established before the price
turns lower. The new round of selling sends the stock
modestly lower on reduced volume. After several more
sessions the stock moves below the lows made at point (a) but
volume contracts further. Just as it begins to look as
though a real decline is underway there is a new positive
fundamental development and the stock begins to move higher (d).
As the rally accelerates volume increases dramatically, buyers
overwhelm those taking profits. Over the next 1-2 sessions the
stock moves through the high set at point (c) and volume surges
further. This triggers an upside breakout (point (e)).
The next session several Wall Street firms either make new
"buy" recommendations or reiterate existing
recommendations. The stock opens higher and goes on to make
significant new highs in the weeks ahead.
How are Technical Targets
Derived?
The technical target for a bull flag
pattern is derived by adding the height flag pole to the eventual breakout
level at point (e).
Bull Flag for
Infospace Inc.
Vital Signs
-
Bull flag formations involve two
distinct parts, a near vertical, high volume flag pole and a
parallel, low volume consolidation comprised of four points
and an upside breakout.
-
The actual flag formation of a
bull flag pattern must be less than 20 trading sessions in
duration.
-
Most flag patterns occur
at the middle of the larger move higher for a stock.
-
Upside breakouts
often lead to small 2-3% rallies followed by an immediate test
of the breakout level. If the stock closes below this
level (now support) for any reason the pattern becomes invalid
symmetrical
triangle 
bullish
pennants
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