What is a bear flag pattern in crypto trading?
What is a bear flag pattern?
The bear flag pattern refers to a technical analysis chart pattern that appears during the times when a market is trending downwards. Simply put, this chart pattern represents a small pause in the downward trend before the continuation of the bear phase.
Chart patterns are one of the most commonly used tools by traders for determining the direction of asset prices. Many trading analysts utilise chart patterns to spot entry and exit points in a certain trade. Price patterns are evident throughout all financial markets, including the cryptocurrency market as well.
To learn more about chart patterns in the crypto market, why not read this article: 'How to read crypto trading charts & patterns'.
The pattern is characterised by a downward-sloping flagpole followed by a consolidation phase which indicates a sharp decline or continuation of the downward trend.
Bear flag patterns mirror a flagpole and a flag, representing the opposite of a bullish flag pattern as it forms when asset prices decline. Bearish flag patterns indicate that declining prices may continue to fall in the upcoming period, meaning that the bearish trend will continue.
What does a bear flag pattern look like?
A bear flag is made of two components. It starts with a flagpole representing a broad drop in price. The bear pattern’s flagpole can be spotted by several significant bearish indicators such as support breaks.
Once this chart pattern has started to appear, it marks a period of cooling off or consolidation from the initial downward movement. The consolidation makes prices go up rather than down.
The bear flag pattern is characterised by two parallel diagonal lines that form a range, and the flag pattern can either be confirmed or invalidated by the breakout of that range. In other words, a bearish breakdown means that the bear flag pattern has been confirmed, while an upward breakout would invalidate this chart pattern.
The anatomy of a bear flag formation
Flag formations are a vital part of the technical analysis as it is used to interpret how the asset’s price behaves in the relevant market. Understanding flag formations is essential for traders and investors to identify potential trend continuation patterns or reversals.
Spotting a downtrend is based on examining specific technical indicators such as trendlines, moving averages, and chart patterns such as bull and bear flags.
However, the flagpole refers to a rapid price movement on the trading chart and represents the main component of a flag formation. This type of movement is typically spotted following a significant breakout.
The main features of a flagpole are its marked length and momentum. Traders utilise the flagpole data to spot potential entry and exit points and the consolidation phase that should follow up. This phase presents a brief pause in the momentum, making a place for either a bullish or bearish continuation.
The final element is the breakout which emerges when the price breaks below the lower trend line of the bear flag pattern. The breakout announces a continuation of the initial bearish trend and leads to further price drops.
How do you identify a bear flag pattern?
To accurately identify the occurrence of the bearish flag pattern and predict future price movements, it is essential to understand the whole cycle of the bear flag pattern. Let's explain them briefly.
A sharp price drop
The bear flag chart pattern starts with a sharp price decline which represents the flagpole. This price decline commonly happens because of increased selling pressure in the relevant market.
The abrupt price decrease is vital since it creates the momentum needed for the subsequent stages of the bear flag pattern. If you take a look at a candlestick chart, the flagpole would be represented by a chain of long bearish candlestick patterns, indicating a broad sell-off pressure.
To learn more about crypto price charts and what candlesticks say about the market, we suggest reading this article: 'What are crypto price charts?'.
The consolidation phase
The initial price decline is followed up by the consolidation phase which amounts to forming a rectangular-shaped flag. The asset’s price integrates within a certain range and indicates a brief pause in the downward movement.
The consolidation phase is characterised by the formation of parallel trend lines that encircle the price movement. The upper trendline links the higher lows, and the lower trendline connects the higher highs.
During this phase, trading volume typically decreases which demonstrates a drop in market participation and a potential break in the selling pressure. This phase is temporary and demonstrates only a brief respite before the continuation of the downward trend.
What happens next?
The next thing that happens is the flag sloping in the opposite direction. In other words, the flag portion of the bear flag chart pattern slopes in the opposite direction of the initial sharp price drop and creates a visual resemblance of a flag.
The breakout point
When the asset’s price breaks below the lower trendline of the flag, it is considered that the bear flag pattern is confirmed. The breakout usually appears when the trading volume goes up which signifies the restart of the bearish trend.
How does it differ from a bull flag pattern?
A bull flag pattern represents a bear flag’s inversion- the flagpole presents an upward trending line with a temporary downward consolidation until the price breaks out into an uptrend movement.
However, there are several other differences between bull and bear flag patterns so let’s explain them briefly.
Bear flags are featured by a steep decline in price, followed by a consolidation phase that is moving slightly upward or sideways. On the other hand, bull flags are featured by a sharp increase in price, followed by a downward movement or sideways consolidation stage.
Furthermore, bear flag patterns predict a continuation pattern, while bull flags suggest a restart of the bullish trend, with prices expected to break above the flag’s upper boundary.
As for trading volume, bear flag patterns are associated with high trading volume during the flagpole’s formation and lower trading volume during the flag phase followed by an increase at the breakout point downward.
On the other hand, bull flag patterns are associated with high trading volume during the pole formation and decreased volume during the flag phase, followed by an increase in trading volume during the upward breakout point.
The identification of a bearish or bullish flag pattern implies divergent trading strategies. For example, during a bearish market sentiment, crypto traders typically consider the short-selling strategy at the breakout point below the flag or exiting long positions concerning continued price drops.
Contrary to bear flag patterns, traders look to enter long positions during the bullish phase or purchase assets at the breakout point above the flag because of anticipated price increases.
Examples of bear flag patterns
A few examples of identified bear flag patterns in the last few years exist.
For example, in January 2018, Bitcoin experienced a significant price decrease and a formed bearish flag pattern. The following consolidation stage confirmed the bearish market sentiment; when the price broke below the flag's lower boundary, it announced a further downward trend.
In September 2020, during market uncertainty, Ethereum went through a significant price drop and formed a bear flag pattern. The price breakout point below the flag's lower boundary validated the bear flag pattern and signified a continuation pattern of the bearish trend.
What does a failed bear flag pattern look like?
To efficiently manage risks and mitigate financial losses, it is important to be able to recognise a failed bear flag pattern. A failed bear flag refers to false signals in bear flag trading strategies that appear when an expected bearish continuation pattern reverses into a bullish trend.
A failed bear flag is associated with several key features. The first feature is the stable support level- the price doesn’t break below the flag’s lower support level which is an important element in confirming bear flags. The stability in question announces a potential reversal in market sentiment.
Secondly, if the volume decreases modestly instead of dropping significantly, this means that the bearish momentum is weak.
The third element represents a bullish breakout; if the price breaks above the upper resistance level, it is likely that a bullish reversal will happen. Additionally, if the previous price levels are retested with an increase in trading volume, it commonly points to the appearance of a bullish trend as a reversal from the expected bearish pattern.
How to trade crypto with bear flag patterns?
When you have accurately spotted a bear flag pattern, it is important to be aware of suitable trading strategies. As mentioned many times before, crypto trading requires a deep understanding of financial concepts and market dynamics.
Traders, either crypto or traders on traditional financial markets, tend to initiate short positions when the price goes below the lower line of the bear flag. This strategy is also known as short-selling, and traders seek to gain profits on the downward momentum.
Secondly, traders tend to set profit targets and utilise technical indicators as well as support levels to spot potential price targets. This strategy helps in finding appropriate exit points and managing risks.
When it comes to risk management strategies, crypto traders commonly implement stop-loss orders above the upper trendline of the bear flag to limit potential financial losses in the case of a failed bear flag or a bullish reversal.
Finally, it is important to consider the timeframe in which the bear flag is spotted because patterns observed in higher time frames are usually likely to produce stronger price movements. Aligning a trading strategy with the timeframe in which the bear flag is identified has the potential to mitigate losses.
Pros of a bear flag pattern
If identified accurately, the bear flag is a valuable technical analysis tool for spotting potential downtrends in crypto markets. Let’s briefly explain some of its upper-hands.
Clear signals and efficient risk management techniques
Since the main advantage of bear flags refers to their ability to signify potential downtrends in the crypto market, traders can implement effective risk management strategies to minimise losses if the market moves against the anticipated bearish sentiment.
Timing and versatility
Traders utilise the bear flags to accurately time their entry and exit points. For example, entering a short position after the price breaks from the flag and exiting near the projected profit target improves the trade’s efficiency.
Since a bear flag pattern can be observed across multiple timeframes, traders can apply this chart pattern in divergent contexts. By spotting a bear flag pattern, crypto traders can scale their strategies and adapt to different timeframes and market dynamics.
Cons of a bear flag pattern
However, there are several limitations to this technical analysis tool each trader must be aware of. Here's a short list of potential disadvantages.
The occurrence of false signals
The bear flag pattern is not bulletproof so it can produce false signals sometimes. For example, sudden shifts in market and investor sentiment, unexpected macroeconomic events or volatility can invalidate the pattern.
The efficiency of the bear flag pattern is linked to market conditions as well. During times of high market volatility, chart patterns can turn out to be less reliable than usual.
A lack of knowledge
To identify a bear flag pattern precisely, traders need to interpret trend lines and price movements. Not being educated enough can lead to false interpretations.
Relying solely on the bear flag pattern without any additional confirmation increases the risk of reaching inaccurate trading decisions. Efficient crypto trading based on the bear flag pattern needs confirmation through market analysis tools or technical indicators.
Is the bear flag pattern a reliable indicator?
Keep in mind that nothing in this article is intended as or shall be understood as financial advice. When dealing with financial markets, either traditional or crypto, it is important to demonstrate a high level of financial responsibility and do your research as well as consult a professional.
A bear flag formation is a frequently used technical analysis tool considered by many traders as reliable. Since it is typically used to spot the continuation of a bearish trend, many traders, especially day traders, tend to use it.
While it is considered that a bearish pattern encompasses a higher rate of accuracy, it must be correctly identified. If the trader has enough knowledge to accurately spot the bear flag pattern, it can provide clear potential entry points.
Traders should always remain cautious when reading chart patterns and consider implementing additional trading indicators to reach informed trading decisions and manage potential risks.
For example, false breakouts or false signals may occur or a bear flag can turn out to be a momentary period of consolidation before a bullish reversal happens as well as a change in market dynamics.
Similar to the bull flag pattern, bearish flag patterns are reliable technical analysis tools when used correctly. However, crypto traders should always remain cautious and implement suitable risk management techniques.
To trade responsibly on the crypto market, it is essential to obtain enough knowledge to navigate all of these financial concepts. If you are a newcomer to the world of crypto trading, we suggest enrolling in one of our Learn Crypto Academy’s courses to ace the basics of crypto trading.