Bear Flag in the Making?

23 November 2012

Introduction

Bear flag is an interesting trading pattern. Many traders reaped profits by being able to identify a bear flag in advance. This article will help readers to identify the upcoming of this pattern and hope we all can also profit from the stock market.

What’s a Bear flag Pattern

Bear flag usually happens during a downturn when the price is below the 200-day MA. During this time, investors will lose interest and have sold away their stocks. Up to a point, market will stop “bleeding”. Some buyers will start coming back to do “bottom fishing”. Then the price would fluctuate within a range, which is often called “consolidation”. It may bounce above or drop below but generally, it will trace an ascending channel or triangular pattern as shown and price will go up slowly. The significant behaviour to watch out is the decrease in the trading volume as the price increases. The volume will suddenly jump at the end of the bear flag formation when the support is broken. The bear flag will end when price and volume again diverges as shows.  If the price breaks the support or resistance and the volume does not jump, it is likely the breakout is unreliable.

When bear flag is identified, the price will usually drop significantly below. The bear flag formation may be as short as 4 to 5 days and may take as long as 3-5 weeks. Other significant behaviours are

a) price never exceed Fibonacci 0.68 marked from the bottom of the “mast”;

b) MACD fails to pick up when recovered above 0

c) +DI of Directional Index never take off after crossing above –DI.

 

Have We Got the Pattern Before?

There are many such bear flags happened before. The biggest one just about 4-years ago in 2008. Then the author in Sept 2008 predicted that the market would fall about 30% or 800 points from 2,600 points to 1,800 point. The market eventually dropped below 1,600 points before recovering in March 2009.

The following is the chart for DOW during that period:-

Notice the divergence between the price and volume first occurring in Nov 2007.  When the first support was broken there was no jump in volume and the falls was not great.  It was not until Oct 2008 when that support was broken, the volume jumped 3 times with a hefty fall after that. The +DI was struggling to go above –DI but it never succeeded. Also the MACD never crossed above the 0 level convincingly. The target was set to around 770 points or about 30%.  There are altogether 4 bear flags from Nov 2007 to Jan 2009.

Is This Going to Repeat?

It is hard to tell right now because the bear flag has not even completed yet. However, the developing bear flag has all the ingredients; for example, the divergence in price and volume, the negative +DI and the MACD etc. One might have to wait for the price to touch the 200-day MA and plunge below the flag pole before confirming the bear flag.   Once the price rises above Fibonacci 0.618 marked from the bottom of the “mast”,  the bear flag pattern will be neutralised.  The last failed attempt to form a bear flag was around September 2011 when Operation Twist was announced.  Volume did not spike much. The one in June 2012 did not materialised because it was neutralised.  QE3 came in Sept 2012 as if investors were expecting it.

How To Trade?

It is definitely not the time to do bottom fishing. Intraday or short term trading is recommended.

Update 1 : 8 December 2012 -Bear Flag Forming

Last night, US index closed mixed.  Dow Jones closed up 81.09 points, or 0.6%, to 13,155.13.  The S&P advanced 4.13 points, or 0.3%, to close at 1,418.07.  Better unemployment reports was the reason.  However, Nasdaq went down 11.23 points, or 0.4%, to close at 2,978.04 due to poor Apple's stock performance.  The updated chart of DOW is as shown:-

The position still remain the same with volume divergence and negative MACD,  although there was a positive sign in +DI.  The RSI also gave hope of DOW crossing over the 61.8% Fibonacci resistance.  But the 50-day MA is still falling and had crossed under the 100 MA. The Stochastic chart showed overbought sign.  These are not quite in favour of DOW crossing the resistance.  DOW will have to show commitment going ahead with heavy trade volumes when crossing the line.

Update2:  19 December 2012- Bear Flag Neutralized

The quick exchanges between President Obama and Speaker John Boehner on fiscal cliff issue sent DOW back on track to higher ground this week.  The triple-digit rise, its first such two-day streak since July, seen DOW  finished at 13,350,  passing above the 61.8% Fibonacci resistance of 13,200 to neutralize the Bear Flag.

DOW made 2 attempts to neutralize the bear flag.  The first attempt on 10 December failed.  This second attempt showed considerable improvement with rising volume and a golden cross to support the cross over.  Barring any unforeseen circumstances,   DOW should rise to test the next resistance which is around 13,600.

Update 3 : 23 December 2012  Weakening Supports (revised on 25 December 2012)

The pulling out of the Tax Bill in the House by Speaker Boehner sent DOW falling on Friday to a level below the critical support of 13,200.  DOW made attempt and failed to cross the 70% Fibonnaci resistance level.

The issue posed some dangers ahead for DOW with the following signs showing up in the indicators

1.  Falling RSI ;- falling below the trend line
2.  Falling +DI and Rising -DI:- showing deteriorating performance
3.  Flattening MACD ;-  Showing diminishing hope for a recovery
4.  Breaking down rising Wedge :-  showing critical support being tested and broken with heavy volume support

The only consolation is the rising 20-day MA which now showing a Golden cross being formed after cutting up above the 50-day MA. 

Whether DOW could pick up and resume its climb to test the resistance of 13,600 will be much depend on whether President Obama can resolve the "fiscal cliff" issue before year end which is less than 7 days to go.  Judging from the heavy volume,  the danger of remaking the bear flag could become real if DOW continues to drop and failed to recover the 0.618 Fibonnaci resistance level.

Update: 8 Jan 2013 Bear Flag Null

DOW jumped 2.5% or 331 after US averted the fiscal cliff issue.  The bear flag was null and now testing the resistance of the rising wedge after having broken down on 23 December 2012 with appreciable volume.   Unfortunately,  in the process, DOW formed last bullish engulfing on 4th Jan 2013 followed by a bearish engulfing candlestick as a confirmation.  It is likely that DOW will fail the test to break the wedge and instead,  head down to test the 200 day MA @ 13,000.

 

Declaration: The author has no short position.  Readers should verfiy the information before using any in this article for trading purposes.