In the world of trading, price action is one of the most fundamental and effective techniques that traders rely on. Instead of trying to identify signals, price action trading focuses on reading raw price movements in charts.
Under this approach, some patterns tend to be popular because they work well and present a high probability. Among these, flags, pennants, and wedges represent the most well-known patterns used in technical analysis. Let’s look at each of these and how you might apply them in your trading system.
Flags: A High-Probability Setup
Flags are continuation patterns, indicating a brief consolidation before the trend continues in the same direction. These patterns are easy to identify and are highly effective when used in trading, especially if they appear after a strong price move.
How to Identify Flags:
- Top of the Flag: In identifying the flag pattern, the first point to look for is the top of the flag, which has one or two distinct tests.
- Bottom of the Flag: Again, find the bottom of the flag using three separate tests to increase accuracy.
- Flag Shape: Flags are often identified by the presence of upward or downward sloping channels. They do not have a point like other chart patterns, for example, pennants or wedges.
Trading Flags:
A flag pattern can be traded by waiting for the breakout of the channel as a continuation signal of the trend. Place the stop loss at the opposite side of the channel. Flags are best for second chance scalps where volume increases. This pattern, when traded appropriately, offers significant potential for profits with minimal risks.
Pennants: A Momentum Builder
Pennants are also a continuation pattern but differ in structure from flags. They often form after an extreme price move and represent the consolidation period when the price finally breaks out to continue in its previous direction.
Finding Pennants:
- Flat Lows: Look for flat lows that the price tests multiple times on the same level, thus setting up a pretty defined support.
- Down-sloping Highs: The high should touch a down-sloping line forming the typical pennant shape.
Trading Pennants:
A pennant breakout normally gains strength or pressure as time goes on rather than making an immediate strong move. It is for this reason that a change of expectations is needed. Having made the breakout, watch for the continuation of higher lows and higher highs. For stronger moves, look for high volume breakouts that would accelerate the price upwards. Rather than expecting a quick move, expect a steady build-up as the trend continues.
Wedges: Volatility and Directional Clarity
Wedges are probably the most dramatic-looking of the three patterns, showing converging trendlines and heightened volatility. The main advantage of wedges is their clear directional thrust and the explosive moves that typically follow a breakout.
Finding Wedges:
- Lower Trendline of the Wedge: Find at least three points on the bottom that clearly connect, creating the lower trendline.
- Top of the Wedge: The higher trendline ideally should display two or three contact points, creating an angle showing a down-sloping line.
- Volatility Compression: The power in the wedge pattern increases as price volatility starts to compress so that the pattern begins to taper to a sharp point.
Trading Wedges:
After a wedge pattern has been identified, wait for an immediate breakout, which is often accompanied by high volume, as a signal that shows the price move continues. The breakout should follow the direction of the initial trend, and usually, the movement is fast so that you benefit from it speedily.
Place your stop ideally below the downtrend line for a proper risk management. In case the price would pull back, expect it to retrace not more than half of the actual move. This type of breakouts usually makes a fast-sustained move in the direction of the move, which affords the trading opportunity to some traders.
Conclusion
Mastering flags, pennants, and wedges can greatly enhance your price action trading strategy. These high-probability patterns are visually distinct and based on the psychology of market movements. By realizing how to recognize and trade these patterns, you can have an edge in the market and improve your trading performance.
- Flags provide excellent opportunities for second-chance scalps with strong risk-to-reward ratios.
- The pennants build the momentum gradually, so trade the stocks with patience and volume vision.
- The wedges provide the explosive price movement to offer a quick and high profit trades at breakout conditions.
The more you practice and refine your skills in identifying these patterns, the more intuitive you’ll become at trading and capitalizing on high-probability setups. Make flags, pennants, and wedges a part of your trading arsenal, and you’ll be seeing an increase in your success rate.