A “bull flag” formation appeared on the monthly crude oil chart in early March 2008, which accurately predicted the ensuing price advance to $147 per barrel.
Flags are consolidation patterns within the existing price trend. In an uptrend, the formation truly resembles a flag. It stands atop a “flagpole” and slants downward in the shape of a parallelogram. When formed quickly and compactly, this chart pattern is considered among the most reliable for forecasting the next price move.
A brisk upmove in price precedes the formation of a classic bull flag. The advance forms the flagpole and is accompanied by good volume. The normal behaviour following most rapid price moves is for some long participants to take profit. This causes retrenchment or consolidation. The chart action tends to be minor as prices rise and fall within the context of a downward bias. A pattern of lower highs and lows develops until the profit taking has run its course. Then, new buying surfaces and the re-establishing of long positions stabilizes price and shortly turns the market back up. The higher prices generally attract more new buyers. The bull flag pattern is completed when the buying propels prices beyond the formation’s upper boundary.
A projection for the next advance may be arrived at by measuring the vertical distance of the flagpole and adding it to the point at which prices break out of the flag’s upper boundary.
Flags that are very loosely formed and are broad in extent lack the degree of reliability of the smaller, more compact pattern. The latter usually requires relatively little time to develop.
Farmers who recognized this “bull flag” formation could have hedged their fuel requirements and avoided paying the 40 per cent increase in fuel over the past four months.
Indicating trend reversals
In most cases, “rectangles” are regarded as a continuation or sideways consolidation pattern, in which prices having been in an obvious trend, will pause for several weeks or months without making progress. The market may be digesting its advance or decline.
A rectangle formation consists of a trading range which is bounded on both the top and bottom by horizontal lines. Within this range, the price must form at least two tops and bottoms.
Less than one-third of the time, this pattern will evolve into a legitimate trend reversal. As a general rule, rectangles as reversal patterns are most likely to occur after a downtrend. Thus, they form a bottom prior to the start of a new advance, as evident in the crude oil chart.
Once prices break out of the rectangle, the initial price objective is the height of the sideways trading range. Twenty years ago, one could rely on prices having follow through in the direction of the breakout, but not any more. Often, rectangles will have false breakouts. This occurs when prices push through an upper or lower boundary, reverse, and then break out and continue in the opposite direction.
Since breaking out of a prolonged sideways trading range, crude oil prices have more than tripled in four relatively short years, with 40 per cent of that advance in the past four months. This is an excellent illustration of how the longer a market goes sideways, the further it will run after the breakout.
For years, crude oil prices were confined to a $30 trading range, and now prices gyrate $12-$15 in only a few days. The steep line of support has thus far proven to hold every time prices experienced a downward correction in each of the past four months. This bull market may have wobbled from to time, but the “trend is your friend”, and unless prices break below that line of support, there has been no evidence of a major top yet.
— David Drozd is president and senior market analyst for Ag-Chieve Corporation, a Winnipeg-based grain marketing service with clients across Western Canada. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding in technical analysis of the markets involved in agriculture. The information contained herein is deemed to be from sources that are reliable, but its accuracy cannot be guaranteed. Visit Ag-Chieve online for more educational tools and ideas about grain marketing.