4# Bear Flag (Continuation Pattern)

• 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 ofthe breakout level. If the stock closes above this level (now resistance) for any reason the pattern becomes invalid.

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 bargainhunting.

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 secondshort 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.