CHART PATTERNS
Is The Traditional Measuring Formula Still Relevant Today?
Measuring Flags And Pennants
by Markos Katsanos
This new statistically derived formula can help you estimate
price targets more accurately.
Flags and pennants are my favorite formations,
and I have used them in my trading for some time. In using them, I found
that my exit strategy and profit objective was far from optimal. The classical
method used for measuring these common and useful formations is simple
and straightforward, but how accurate and reliable is it? It's difficult
to find technical literature that provides any statistical studies on the
subject. In fact, it is Robert Edwards & John Magee's classic Technical
Analysis Of Stock Trends, that standard of the industry, that provides
the measuring formula and most other information on the subject. Given
the limited amount of statistical studies on the subject, I decided to
investigate.
I found 100 flag, pennant or similar short-term consolidation patterns
for the past two years (2003-04) using daily charts. My criteria for including
a pattern in the list was, first of all, a steep and quick price rise leading
to the formation of no less than 20% from the lowest point of the flagpole.
I excluded bearish flags that formed after a declining price trend from
the current study. I then made a note of the price level and the date of
the lowest and highest point of the pole, the point where prices break
out above the upper trendline of the formation, and the breakout up to
the first short-term top. I also noted the volume trend during the formation
pattern.
Statistical analysis of the results revealed some surprising findings
contradicting widely accepted principles. In this article, I will discuss
the measuring formula and formation characteristics such as volume and
pattern length among others.
FORMATION CHARACTERISTICS
Flags and pennants can be categorized as continuation patterns because
they break out only in the prevailing trend. This is an important trading
advantage over similar formations such as triangles, because the direction
of the breakout is known in advance. They usually represent only brief
pauses in a dynamic market and are typically seen right after a steep,
quick move.
FIGURE 1: FLAG. On February 10, 2004, Novatel Wireless (NVTL)
broke out from a flag formation. Note the volume decline in the bottom
window depicted by volume linear regression line (in blue).
...Continued in the April issue of Technical Analysis
of STOCKS & COMMODITIES
Excerpted from an article originally published in the April 2005
issue of Technical Analysis of STOCKS & COMMODITIES magazine.
All rights reserved. © Copyright 2005, Technical Analysis,
Inc.
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