FLAGS

Flags are a pattern on a stock chart that describe a bullish behavior and should be bought in the “quiet” area. When a stock rises big in one day or maybe just a few days the graph looks like one line going up, the volume must also be very high. Then the inevitable consolidation (or maybe a small sell off) will occur as people consider the stock has moved too high too fast. The stock will now do nothing and move sideways for a while, it may even fall a little. This sudden rise on high volume can be visualized as a flag pole and the sideways to slightly down action on low volume the actual flag. This quiet period on low volume is the buy area before the next big rise (if it occurs).


Consider it from a psychological point of view. The buyers drive the stock up since they know something good about this stock. Maybe it’s an earnings report and it is public knowledge or maybe it is just insiders which have information that is not yet public. Then as the sellers come in the stock will move sideways to down for a while until all sellers are exhausted. As the buying and selling dry up to negligible levels the price action gets extremely quiet. If there is demand for the stock the buyers will get impatient as they see the stock will not fall any more. Realizing they can’t buy stock any cheaper they then pile in again and drive the stock up forming a new pole of another flag as it breaks out to the upside again. The graph below courtesy of www.bigcharts.com indicate this if you examine the circles in the price and volume charts.

Of course if there are no more buyers for this stock the quiet area is viewed by the sellers as being a point where the stock will not go any higher. The sellers want as high a price as possible but give up on the stock going any higher. At this point they may start selling on volume as all the last flag breaks down. At the end of this chart you can see the heavy selling coming in. At this point you should be lightening up on your holding of this company, not buying more.

Regarding current action in the stock market the investor should be cautious at this point. Do not buy any new positions while the Dow index is trading under its 50 day moving average (see yesterday’s blog). The trader can still add high volume breakout stocks to his or her watch list but be sure to remove stocks from your watch list that are clearly breaking down on high volume, these are no longer potential buys. Remember in a down market 90% of stocks will get hit, even the good ones. Remember to move the stops up on any positions you currently own. In any case the investor should only have one or two positions that are negative since previous blogs have indicated you wait for a new investment to break even before you buy any other new companies. This is how you limit your downside losses. It’s always nice to have lots of profitable positions and only one or two potential losers. Those losers will have a maximum of 10% loss and maybe less if you have been moving the stop up gradually as the stock rises. Also its only 10% of a very small position since companies in which you have been adding additional positions are already in profit and your stop is set to break even at the very least.