Chart Patterns: Flags and Pennants

By Steve Hill

Founder, WinWayCharts

Stephen Hill is Founder of WinWayCharts. For the past 12 years he has been involved in all aspects of WinWayCharts, from support and sales to programming and education. Steve is a frequent speaker at events in the U.S. and Europe, talking on subjects as diverse as Portfolio Simulation TechniquesAdvanced Chart Pattern Analysis and Trading System Design.

Chart pattern analysis, often thought of as part science part art is a key element in many traders decision process. Common patterns like double tops and bottoms are somewhat self-fulfilling, given that most of us can see these patterns occurring. Measures of what constitutes a double top or bottom in good analytical terms we’ll save for another article. In this this article we are focussing on two of my favorite chart patterns; Flags and Pennants

Flags and Pennants are Consolidation or Continuation Patterns

These patterns break out in the direction of the previous trend, confirming the existing trend, suggesting that investors are considering whether the market is overbought or oversold but ultimately deciding to confirm the existing trend. Flags and pennants are of two types, bullish or bearish

Flags and pennants are generally considered continuation patterns as they breakout in the prevailing trend direction. They represent a brief pause especially after a steep run up in an active ticker. They are a fairly common and useful for short term trading.

Bullish Flags – formation

Lower tops and lower bottoms bounded by two parallel trendlines with pattern slanting against the prevailing trend are considered bull flags (figure 1).

Figure 1Bullish flag pattern

Bearish Flags – formation

Higher tops and higher bottoms bounded by two parallel trendlines with pattern slanting against the prevailing trend are considered bear flags. (figure 2).

Figure 2Bearish flag pattern

Elements of bullish flags

  • A rapid and steep price rise of around 20% from bottom of the pole to top.
  • Decreasing volume during the formation of the flag.
  • Breakout occurs to the upside with resumption of increase volume levels
  • Flags length excluding the pole classic should be around 10 days, can be less but not more than 20 days.
Figure 3. Whole Foods Market, Inc (WFMI) bullish flag

Bulkowski noted that the high and tight flag performed best. (source Encyclodpedia of Chart Patterns by Thomas Bulkowski).
Some 25% of the patterns are horizontal notes Markos Katsanos. (source Measuring Flags & Pennants: Technical Analysis of Stocks and Commodities vol 23 no 4) bullish flag breakout on increased volume note the pole length is 20% + of the price action and the diminishing volume on the flag.
Elements of bearish flags

  • A rapid and steep price decline of around 20% from top of the pole to bottom.
  • Decreasing volume during the formation of the flag.
  • Breakout occurs to the downside with resumption of increase volume levels.
  • Flag length excluding the pole should be around 10 days, can be less but not more than 20 days.
Figure 4 shows MNST classic bearish flag breakout on increased volume note the pole length is 20% + of the price action and the diminishing volume on the flag.

Bullish Pennants – formation

Pennants look very much like symmetrical triangles, on the end of a pole, typically they are smaller in size and duration (figure 5).

Bearish Pennants – formation

An upside down bullish pennant, the triangle is at the bottom of the pole. (figure 6).

Elements of bullish pennants

  • A rapid and steep price rise of around 20% from bottom of the pole to top.
  • Decreasing volume during the formation of the pennant.
  • Pennants look like symmetrical triangles on a pole, price action is converging.
  • Diminishing volume as pennant forms.
  • Breakout to the upside with re- sumption of volume levels.
  • Pennant length excluding the pole should be around 10 days, can be less but not more than 20 days.Figure 7 shows CDW classic bullish pennant breakout on increased volume
Figure 7CDW Computer Centers (CDW) bullish pennant

Elements of bearish pennants

  • A rapid and steep price drop of around 20% from top of the pole to bottom.
  • Decreasing volume during the formation of the pennant.
  • Pennants look like symmetrical triangles on a pole, price action is converging.
  • Diminishing volume as pennant forms.
  • Breakout to the downside with resumption of volume levels.
  • Pennant length excluding the pole should be around 10 days, can be less but not more than 20 days.

How do you trade flags and pennants?

Katsanos study of Flags and pennants revealed that the average breakout was 45% over an average period of 11 days. Bulkowski noted a 63% average gain. to trade these breakouts, set tight stops at low of day before breakout and use trailing stops once breakout occurs.

Target prices are more difficult to predict as these are continuation patterns, but after 11 days you are beyond the average move in days.

AIQ tip

Once a breakout occurs, use AIQ space on right of the chart (rtalerts only) and advance 11 days into the future. Draw a trendline parallel to the pole trend from the breakout point.

All Eyes on Key Bellwether Support Levels

First the reality.  Nobody knows what the market is going to do.  Yes, I am aware that there are roughly a bazillion people out there “prognosticating” (myself included) about the stock market.  And yes, if one makes enough “predictions”, the law of averages dictates that one will be correct a certain percentage of the time.

 

Still, the market does offer clues.  Sometimes those clues turn out to be false leads.  But sometimes they do offer important information.  For example, Figure 1 displays four major market indexes.  As you can see, in the Aug-Sep-Oct time frame all four of these averages “broke out” to new all-time highs (i.e., The Good News) and then broke back down below the previous resistance line drawn on each chart (i.e., The Bad News).

 

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Figure 1 – Four major indexes breakout then fail (Courtesy  TradingExpert)

 

False breakouts happen all the time.  And the reality here is that sometimes they mean something and sometimes they don’t.  But when all four major average do the same thing, a warning sign has been issued to those who are interested in seeing it.  That’s why it can be useful to seek “confirmation”.  For my purposes I look to what I refer to as my 4 “bellwethers”, which are:

 

SMH – Semiconductors

TRAN – Dow Transportation Average

ZIV – Velocity Shares Inverse VIX Index

BID – Sotheby Holdings

 

These tickers appear in Figure 2 (click to enlarge).

 

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Figure 2 – Jay’s Market Bellwethers (Courtesy TradingExpert)

 

While the major indexes were testing new highs in Aug/Sep and then breaking down in October:

 

SMH – Never really came close to breaking out above its March high

TRAN – Followed the major indexes by hitting new highs in Aug/SP and then breaking down in October

ZIV – Never came anywhere close to its Jan-2018 high

BID – Broke to a new high in Jun/Jul, then failed badly.

 

In a nutshell, the failed major index breakouts were accompanied by absolutely no positive signs from the 4 bellwethers. So, the warning signs were there if one wished to see them.

 

So where are the bellwethers now?  Another close look at Figure 2 reveals that:

 

SMH – the key support level at 80.92

TRAN – the key level for the Dow Transports is 8744.36

ZIV – the key support level is 60.60

BID – a potential support level is 32.95 (the Apr 2013 low)

 

Summary

 

*Given the washed-out/oversold level that many indicators and sentiment surveys have reached…

 

*…Combined with the fact that we are in the seasonally favorable pre-election year (no down pre-election years since the 1930’s)

 

*There is a chance that 2019 could be surprisingly bullish, and shell-shocked investors should not stick their heads in the sand to the possibility.

 

At the same time:

 

*Based solely on trend-following indicators ALL of the major market indexes are technically in confirmed bear markets.  As a result, there is absolutely nothing wrong with having some portion of one’s capital in defensive positions at the moment (30% cash or short-term bonds?).

 

*Keep a close eye on January performance.  A bullish January would be a positive sign just as a negative January could – in this case – signal a continued market decline.

 

*Keep a close eye on the 4 Bellwethers relative to their respective support levels.

 

In a nutshell:

 

*Up January + Bellwethers holding above support = GOOD

 

*Down January + Bellwether breaking down below support = BAD

 

Those are all the “clues” I can offer at the moment.

 

Jay Kaeppel

 

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

The SPX ‘Magic Number’

According to one simple technique the “Magic Number” for the S&P 500 Index is 2872.87.  According to this simple technique if the S&P 550 Index closes above this number the stock market “should” continue to be bullish for at least another year.

 

Sounds optimistic? Well, there certainly are no “sure things” in the financial markets.  Still, let’s take a closer look.

 

The Simple Technique

 

The technique I mentioned works like this:

 

When the S&P 500 Index:

 

*Closes at its highest price in the past 252 trading days

 

*For the 1st time in the most recent 126 trading days

 

*It generates a bullish signal for the next 252 trading days

 

In essence, we are talking about buying when the index makes a 1-year high for the 1st time in 6 months and holding for 1 year.

 

Figure 1 displays the most recent previous buy signal that occurred on 7/11/16.  The sell date was 252 trading days later on 7/11/17.

 

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Figure 1 – 2016 Signal (Courtesy TradingExpert)

 

Figure 2 displays the signal before that which occurred on 2/27/12.  The sell date was 252 trading days later on 2/26/13.

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Figure 2 – 2012 Signal (Courtesy TradingExpert)

 

Figure 3 displays all the signals since 1933.

 

Buy Date Sell Date Buy Price Sell Price %+(-)
5/27/33 4/6/34 9.64 10.95 +13.6
5/18/35 3/20/36 9.87 15.04 +52.4
10/6/38 8/9/39 12.82 11.78 (8.1)
10/7/42 8/10/43 9.17 11.71 +27.7
6/1/44 4/7/45 12.31 13.84 +12.4
5/15/48 4/8/49 16.55 14.97 (9.5)
10/5/49 8/23/50 15.78 18.82 +19.3
3/5/54 3/4/55 26.52 37.52 +41.5
8/4/58 8/4/59 47.94 60.61 +26.4
1/10/61 11/2/62 58.97 57.75 (2.1)
4/15/63 4/15/64 69.09 80.09 +15.9
4/24/67 4/25/68 92.62 96.62 +4.3
4/30/68 6/9/69 97.46 101.2 +3.8
1/8/71 1/6/72 92.19 103.51 +12.3
2/7/72 2/8/73 104.54 113.16 +8.2
6/24/75 6/22/76 94.19 103.47 +9.9
8/1/78 7/31/79 100.66 103.81 +3.1
8/14/79 8/12/80 107.52 123.79 +15.1
10/8/82 10/6/83 131.05 170.28 +29.9
11/7/84 11/7/85 169.17 192.62 +13.9
10/19/88 10/18/89 276.97 341.76 +23.4
5/30/90 2/13/92 360.86 413.69 +14.6
7/30/92 7/29/93 423.92 450.24 +6.2
2/6/95 2/5/96 481.14 641.43 +33.3
9/3/03 9/2/04 1026.27 1118.31 +9.0
11/5/04 11/4/05 1166.17 1220.14 +4.6
10/13/09 10/13/10 1073.19 1178.1 +9.8
11/5/10 11/4/11 1225.85 1253.23 +2.2
2/27/12 2/26/13 1367.59 1496.94 +9.5
7/11/16 7/11/17 2137.16 2425.53 +13.5

Figure 3 – Previous Signals

 

Things to note:

 

*27 of the 30 signals (i.e., 90%) have witnessed a 12-month gain

 

*3 of 30 signals (i.e., 10%) have witnessed a loss

 

*The last “losing trade” occurred in 1961-1962

 

*The last 20 signals have been followed by a 12-month gain for the S&P 500

 

*The average of all 30 signals is +13.9%

 

*The average for all 27 winning trades is +16.1%

 

*The average of all 3 losing trades is -6.6%

 

*The worst losing trade was -9.5%

 

Two Technical Notes

 

Believe it or not, into the early 1950’s the stock market used to be open on Saturday.  So those days counted toward the 126 and 252 trading days counts.  This explains why the buy and sell dates prior to 1954 were less than one calendar year apart.

 

It is possible to get a new signal before an existing signal reaches it’s Sell Date.  In those rare cases we simply extend the holding period an additional 252 trading days.  This occurred in 1961-1962, 1968-1969, 1990-1992.

 

Figure 4 shows that SPX is very close to generating a new signal.  The most recent high close was in January at 2872.87 which was more than 126 trading days ago.  A new signal will occur if SPX closes above that level.

 

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Figure 4 – Potential new signal forming (Courtesy TradingExpert)

 

Summary

 

The Good News is that this technique has a 90% accuracy rate and that one good day in the market could generated a new buy signal.  The Bad News is that – as I mentioned earlier – there are no “sure things” in the market.  Given that this particular method is on a 20-trade winning streak, it is understandable to think that maybe the law of averages is against it this time.

 

We’ll just have to wait and see what happens.

 

Jay Kaeppel

 

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Dollar and Gold ‘To the Barricades’

This week it is the U.S. dollar and Gold taking their turns testing critical inflection points.

U.S. Dollar

As you can see in Figure 1, on a seasonal basis the dollar is moving into a traditionally weaker time of year.1Figure 1 – U.S. Dollar seasonality (Courtesy Sentimentrader.com)

In Figure 2 you can see that traders have been and remain pretty optimistic.  This is traditionally a bearish contrarian sign.2Figure 2 – U.S. Dollar trade sentiment (Courtesy Sentimentrader.com)

In Figure 3 we see the “line in the sand” for ticker UUP – an ETF that tracks the U.S. Dollar.  Unless and until UUP punches through to the upside there is significant potential downside risk.3Figure 3 – U.S. Dollar w/resistance (Courtesy TradingExpert)

Gold

As you can see in Figure 4, on a seasonal basis the dollar is moving into a traditionally stronger time of year.4Figure 4 – Gold seasonality (Courtesy Sentimentrader.com)

In Figure 5 you can see that traders have been and remain pretty pessimistic.  This is traditionally a bullish contrarian sign.5Figure 5 – Gold trader sentiment (Courtesy Sentimentrader.com)

In Figure 6 we see the “line(s) in the sand” for ticker GLD – an ETF that tracks gold bullion.

6Figure 6 – Gold w/support (Courtesy  TradingExpert)

I would be hesitant about trying to “pick a bottom” as gold still looks pretty week.  But if:

a) GLD does hold above the support area in Figure 6 and begins to perk up,

AND

b) Ticker UUP fails to break out to the upside

Things could look a lot better for gold very quickly.

Summary

As usual I am not actually making any “predictions” here or calling for any particular action.  I mainly just want to encourage gold and/or dollar traders to be paying close attention in the days and weeks ahead, as the potential for a major reversal in both markets appears possible.

Likewise, if no reversal does take place – and if the dollar breaks out to the upside and gold breaks down, both markets may be “off to the races.”

So dollar and gold traders – take a deep breath; focus your attention; and prepare for action…one way or the other.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Here Are The Warning Signs to Watch For

Here’s a number for you – 88%.  Since 1948, over any 10-year period the Dow has showed a gain 88% of the time.  That’s a pretty good number.  It also explains why we should give bull markets the benefit of the doubt (for the record, if you only hold the Dow between the end of October and the end of May every year you would have a showed a 10-year gain 98% of the time!  But this article is not about seasonality per se, so that’s a topic for another day).
Of course, there is a lot of variability along the way, and if you Google “current signs of a bear market” you come up with 4,280,000 articles to peruse.  So, few investors ever feel “contented”.  We’re always waiting for the “other shoe to drop.”
Some Warning Signs to Look For
#1. Major Indexes
Figure 1 displays the four major average – Dow, S&P 500, Nasdaq 100 and Russell 2000 with their respective 200-day moving averages.  In the last few days the Dow slipped a little below its 200-day average, the other three remain above.

(click to enlarge)1aFigure 1 – Four major market averages with 200-day moving averages (Courtesy TradingExpert)

Warning Sign to Watch For: If 3 or more of these averages drop below their 200-day moving average.
#2. Market Bellwethers
Figure 2 displays my four market “bellwhethers” – tickers SMH (semiconductors), TRAN (Dow Transports), ZIV (inverse VIX) and BID (Sotheby’s Holdings) with their respective 200-day moving averages.  At the moment only ZIV is below it’s 200-day moving average but some of the others are close

(click to enlarge)2Figure 2 – Four market bellwethers with 200-dqy moving averages (Courtesy TradingExpert)

Warning Sign to Watch For: If 3 or more of these averages drop below their 200-day moving average.
#3. S&P 500 Monthly Method
In this article I detailed a simple timing method using S&P 500 Index monthly closing prices.  Figure 3 show the S&P 500 Index with it’s “trigger warning” price of 2,532.69 highlighted.

(click to enlarge)3Figure 3 – S&P 500 Index Monthly Method Trigger Points (Courtesy TradingExpert)

Warning Sign to Watch For: If SPX closes below 2532.69 without first taking out the January high of 2872.87
#4. International Growth Stocks
When growth stocks around the world are performing well, things are good.  When they top out, try to rebound and then fail, things are (typically) not so good.  The last two major U.S. bear markets were presaged by a break in ticker VWIGX (Vanguard International Growth) as seen in Figure 4.

(click to enlarge)4Figure 4 – Dow Jones Industrials Average (top) and previous warnings from ticker VWIGX (bottom)(Courtesy TradingExpert)

Warning Sign to Watch For: Technically this one is currently flashing a warning sign.  That warning will remain active unless and until VWIGX takes out the January high of 33.19.
#5. The 10-Year minus 2-Year Yield Spread
This is one of the most misrepresented indicators, so I will state it as plainly as possible:
*A narrowing yield curve IS NOT a bearish sign for the stock market
*An actual inverted yield curve IS a bearish sign for the stock market
Figure 5 displays the latest 10-year minus 2-year spread.  Yes, it has narrowed quite a bit.  This has launched a bazillion and one erroneously frightening articles.  But remember the rules above.

(click to enlarge)5Figure 5 – 10-year treasury yield minus 2-year treasury yield (Courtesy: www.StockCharts.com)

Warning Sign to Watch For: If the 10-year yield minus the 2-year yield falls into negative territory it will flash a powerful warning sign for the stock market and the overall economy.  Until then ignore all the hand-wringing about a “flattening” yield curve.
Summary
We are in a seasonally unfavorable period for the stock market and – as always – we are bombarded daily with a thousand and one reasons why the next bear market is imminent.
So my advice is to do the following:
1. Ignore it all and keep track of the items listed above
2. The more warning signs that appear – if any – the more defensive you should become
In the meantime, try to go ahead and enjoy your summer.
Jay Kaeppel
Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

What in the World to Watch

If an investor were to sit down and peruse the Web looking for guidance regarding the stock market, there is a good chance they would come away bewildered and confused.

So, let’s try to simplify things a bit.

The Current Trend

Here I will defer to:

Jay’s Trading Maxim #14: When in doubt, usually the best question to ask is “What is the trend right now?”

There are always a million and one reasons why an investor may feel doubt.  But answering that simple question can often lead to a much greater deal of clarity.  Like now for instance.

In Figure 1 we see the Dow, Nasdaq 100, Russell 200 small-cap index and the S&P 500.  The key thing to note is that all 4 of them are above their respective 200-day moving average, i.e., “right now” the trend is up.

Which leads to:

Jay’s Trading Maxim #14a: If the trend right now is “Up”, act accordingly.  At least until the answer changes.

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Figure 1 – Major U.S. Indexes in Up Trends (Courtesy TradingExpert)

SPX Monthly Trend-Following

I wrote here and here about a simple monthly trend-following method using the S&P 500 Index.

This method gave an “alert” when the S&P 500 went 3 calendar months (Feb, March and April) without making a new high.

The “line in the sand” is the low during this period of 2532,69.  As long as price holds above this level, this method deems the trend as still “Up”.

It will take a move above the January high 2872.87 to eliminate this line in the sand.  Between here and there there is resistance at 2801.90.

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Figure 2 – S&P 500 Index key support and resistance (Courtesy TradingExpert)

The (Problematic) World

I am not speaking in any geopolitical sense here.  And I don’t want to sound like the Ugly American.  But while the U.S. stock market is “taking care of business” and moving higher, the stock markets of much of the rest of the world are not.  And I am not sure if I should worry about this or not.

But for what it is worth, all 4 regional single country ETF indexes that I created (Americas, Asia/Pacific, Europe and Middle East) and follow are not looking terribly inspiring at the moment.

(click to enlarge)

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Figure 3 – The Rest of the World Lags (Courtesy TradingExpert)

Summary

The trend “right now” is “Up”.  So enjoy.

But maybe check back again soon.  Just in case.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.