Once a trend ends, traders can look at the chart and see the final flag in the trend. Final flag reversals are common because every reversal follows some kind of flag and therefore is a type of final flag reversal. If a trader understands what makes a flag likely to be the last one before the trend reverses, he is in a position to anticipate and trade the trend reversal.
Here are several characteristics that are common in final flags:
- The flag occurs in a trend that has gone on for dozens of bars; therefore the trend traders might begin to take profits and the countertrend traders might become more aggressive. Both will believe that the trend is overdone and is therefore prone to have a larger two-legged correction and evolve into a larger trading range or even a reversal.
- The flag is mostly horizontal and has signs of strong two-sided trading, such as several trend bars in the opposite direction, bars with prominent tails, several reversals, and bars that overlap the previous bar by at least 50 percent. Part IV in book 2 on trading ranges gives more signs of two-sided trading.
- A micro trend line breakout pullback is of a one-bar or micro final flag. For example, when there is a break above a bear micro trend line and the market reverses down, that one- or two-bar breakout often becomes the final bear flag in the micro bear trend. If the sell-off fails within a bar or two and then the market reverses back up from a lower low, double bottom, or higher low, ...