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Technical Analysis of Stock Trends
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Friday September 05, 2008 |
Bear Flags
Technically speaking, a bear flag is a sharp, strong volume decline
on a negative fundamental development, several days of
sideways to higher price action on much weaker volume followed by a
second, sharp decline to new lows on strong volume.
Why Does It Happen?
Bear flags are favored among technical traders because
they almost always lead to large and predicable price moves.
Like all continuation patterns, bear flags represent little more
than a brief lull in a larger move lower. Indeed, in many
cases the flag pattern will actually take shape in the middle of
the ultimate move lower. Like bull flags, bear flags occur
because stocks rarely move in one direction for an extended
period, instead, the move is broken up by brief periods where
traders "catch their breath". These periods are
flags and pennants. The first part of the bear flag pattern
is often called the flagpole or mast. During
this phase the stock price collapses to a reaction low (a)
following some negative fundamental development. Very
often this will be downward guidance, an unfavorable legal
resolution or negative earnings surprise but the change in price
is near vertical as would be buyers are overwhelmed by frantic new
sellers caught-up in the euphoria of the moment. As the
stock collapses some speculators that were smart enough to have
sold short stock at higher levels begin buying to cover short
positions and some less informed investors actually begin
bargain-hunting. At this point the second phase or flag
portion of the bear flag begins. Because the flow of news
and investor sentiment is overwhelming negative, most of the stock
bought by speculators is easily absorbed by nervous sellers in the
beginning but as time passes selling pressures abate and slowly,
the stock price begins to rise on dramatically reduced
volume. It is bargain-hunting that pushes the stock off the
lows but volume is so weak that the rally soon fizzles and the
stock puts-in a short term top point (b). With bearish
sentiment still rampant the next decline threatens to push the
stock to fresh new lows but as the decline begins volume slows
further and the bargain-hunters become more enthusiastic. As
the stock approaches the reaction low price stabilizes and second
short term bottom is established at slightly higher levels point (c).
Buoyed by the fact the stock did not make a relative new low
bargain hunters once again begin buying the stock. This time the
stock rallies slightly higher than point (b) but volume is even
weaker and the rally soon fails (d). During the next
3-4 sessions the stock trades in a narrow range and volume slows
dramatically before the stock begins to slide toward the lows
established at point (c). Over the next 1-2 sessions the
stock moves through these lows, triggering a downside
breakout (e). Over the next session several Wall Street firms
make negative comments or reduce earnings estimates and a new leg
lower begins. The stock opens lower and goes on to make
significant new lows in the weeks ahead.
How are Technical Targets
Derived?
The technical target for a bear flag
pattern is derived by subtracting the height of the flag pole from the eventual
breakout level at point (e).
Bear Flag for
Beazer Homes
Vital Signs
-
Bear 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
bear flag pattern must be less than 20 trading sessions in
duration.
-
Most bear flag patterns
occur at the middle of the larger move lower for a stock.
-
Downside
breakouts often lead to small 2-3% declines followed by an
immediate test of the breakout level. If the stock
closes above this level (now resistance) for any reason the
pattern becomes invalid.
bullish
pennants 
bearish
pennants
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