Flag or Trend?

Beginner Questions
1

Howdy,

Just working my way through Murphy’s excellent book at the moment and had one question - how can you tell the difference between a flag continuation pattern and a trend?

For example, let’s say a pair has been trending down for a few months. On the daily chart, you see it bounce back off a resistance sharply, forming the near-vertical move that is one of the criteria for a flag.

The price then starts trading downwards in zigzags, with the tops of zigzags more or less matching the highs encountered by the downward trend.

In these circumstances, how can you tell the difference between a resumption of a downward trend (as suggested by the lower highs) and the formation of a flag continuation pattern (which would suggest that the market is set to go up)?

For example, here’s the daily chart for USD/JPY - looking at the movement starting in early Jan 2010, how can I tell the difference between a flag and a downward trend?

Cheers for your feedback,
George

P.S. Never knew how addictive technical analysis could get… I now spend hours starting at charts I’m not even planning to trade just to practice reading them.

2

I have also just read Murphy’s book.

My understanding is that the flag is a continuation pattern, meaning you can expect the previous up trend to continue after completion of the flag.

Murphy goes on to state “the flag is at half mast”.
This means you can expect the subsequent breakout to be same length as “the pole” holding the flag up.

Cheers.

3

Samys,

Thank you for your feedback.

Of course, in retrospect, it’s always easy to tell if the formation turns out to be a flag (continuation) or a trend (downward slope).

The problem is - right now, if I had a live position there (which I don’t, of course), would I see the flag and go long because it’s a continuation?

Or would I go short because the previous downward trend should re-assume itself and the flag is little more than a temporary correction?

4

Hi George.

Murphy states that you should expect a break out in the direction of the previous trend. Therefore you should be long awaiting the break out. Or better yet, wait for the break out to be confirmed, then go long!

Murphy claims that the flag is usually a continuation. His criteria for it to indicate a reversal seems to be based on the amount of time the flag takes to form. I think he uses the 3 month figure to indicate a reversal, whilst the continuation forms in around a month.

As with everything in Murphy’s book, he warns against a “failed pattern”, and the fact that patterns are obviously not 100% reliable.

These are simply my interpretations of Murphy’s theory, I am by no means an expert.

Cheers.