There are many chart patterns in the markets and the formations are driven by supply and demand. Most of these patterns have existed in the markets for many years and will likely never disappear because of human emotions. The high tight flag pattern is no different and you can see the same formations today as you could see forming in stocks during the 1800s. If you learn to distinguish these genuine patterns from the random noise created by the market, you can exploit the information to your advantage and gain a tradeable edge. Let’s investigate the high tight flag pattern in detail.
What it looks like
There is an infinite type of variations as to how the high tight flag pattern can look like, but the basic premise is: The instrument (in this post we will focus on stocks) makes a move higher, usually greater than 20%, it takes a break and goes sideways or pull back before it continues higher. The high tight flag is a continuation setup and as a trader you bet on a continuation outcome. This is an example of what a high tight flag can look like.
This is a perfect example. A pattern like this does not come around very often and it would be rated A+ by most traders as it would be very easy to spot and trade.
These patterns occur on every timeframe, from the 1-minute chart to the yearly chart, as you can see in the example of MSFT below. The benefit of focusing on one single pattern is that once you get proficient in trading the pattern, there will be infinite ways to exploit the pattern in the market. If you study all the markets, there will be commonalities everywhere as the price action is driven by humans in some form or another, and this pattern is an example of the market dynamics. Then you might think to yourself, but what about computers/trading programs? Aren’t they exploiting these patterns and thus making the market “efficient”? Well, yes you got a point, and yes, they are trying to. Trading on the lower timeframes is starting to get very fast and competitive, but the programs are made by humans and we as a species are emotional, hence the computers have not taken over the markets yet and there are still exploitable edges.
So, developing a robust system around a pattern like this is an edge, but you have to select the timeframe that works for you.
Why it works, psychology and why it likely will never change
As mentioned earlier, patterns form in every market across the globe at any point in time as long as the markets are open. Below you can see an excerpt from the book “How to make money in stocks” by William O’Neil showcasing a chart of Bethlehem steel from the early 1900s, with his annotations.
This chart verifies the reliability of this particular pattern. It has existed for hundreds of years and will likely never go away, hence it gives traders a viable and definable edge to exploit. And you may ask, why does it work so well when the markets supposedly are efficient? The simple answer is market dynamics are formed by human psychology. The benefit for traders exploiting patterns is that human psychology will most likely never change as we are simple creatures driven by emotions such as greed and fear when participating in the financial markets.
One way to describe why this pattern forms in a simple way is: If a stock makes a leg higher for some reason, the participants who were not participating in the move higher will get their eyes up and watch the stock. Then as the stock encounters sellers along the way it will take a break at some point. If the demand is great enough, the stock will create a range/pull back (take a break) before a new set of participants, usually well-informed traders as they tend to be the first ones to join, buy the stock higher as greed for making money sets in. Remember, they missed the first leg and do not want to miss the second leg higher.
This cycle repeats until all the informed and uninformed participants that want to join have bought their shares. Then as the stock gets extended from a surge in buying pressure, a pullback is inevitable as the informed participants start to sell their shares in order to lock in gains, and as there are no more uninformed investors willing to soak up the selling pressure.
The uninformed investors are people like your colleague at work who has never shown an interest in the markets, your mother, or your old neighbor with no market experience. A great rule of thumb is if you get questions from people without any market experience, the top is likely near.
A well-known recent example of this human behavior is Bitcoin in 2020 and 2021. It has nothing to do with fundamentals, news etc, it’s just pure human psychology. If you study similar bubbles from different time eras, you will find very close similarities.
This form of behavior has always existed as the drivers of this behavior are emotions, greed and fear. But of course, not all high tight flag patterns end up going parabolic as bitcoin did. It is a very extreme example compared to what we are trying to accomplish on a more frequent trading level, but the example above illustrates why the pattern works the way it does.
Volume and how to analyze
When it comes to analyzing patterns in the market, there are a few important indicators to consider. One significant indicator that may give valuable clues is the amount of volume traded. The volume represents the transactions made by investors, or another way to look at it is how much interest there has been in a stock. If a stock runs higher on high volume, it means there is a lot of demand for the stock, which you want as a trader.
If a stock makes a move to the upside, it will encounter sellers along the way and the stock will take a break at some point. Once the stock is starting to go sideways and make higher lows, meaning the buying pressure remains while sellers are getting exhausted the volume tends to decline — this is a sign of accumulation. Had the reverse been true and we saw volatile and erratic price action with high volume spikes, it would be a sign of distribution. Being on the same side as the drivers of prices is essential if you aspire to make money in the market. How will you make money buying a stock if there are no participants to push the stock higher after you bought?
When focusing on this type of pattern it helps a lot to be early in the trend as you want to be one of the “informed” investors as talked about earlier. You are early if you buy after the first or second breakout in the uptrend. The setups in the picture below are not good, but it represents what I’m trying to convey. The stock makes a move, takes a break, then continues. The first two worked and the third didn’t.
Being early is key because the probability of follow-through is reduced dramatically for every setup. Remember, there are only a finite number of investors willing to drive the price higher before it has to reset/go sideways for some time. In this case, the stock had to take a break once it printed the third setup and had a false breakout, it’s still basing.
One thing to be aware of that will add to your edge is if you focus on stocks that are in longer-term uptrends but coming out of a sound base like in the example below. It’s because it ensures there has been recent demand for the stock. Then, the basing period is a part of the natural cycle and will reset the chart for a new batch of investors to drive prices higher.
There are many ways to make money in the market, but you have to settle for something with an edge and build deep expertise around that phenomenon. If your system does not revolve around a proven edge, you are simply nothing more than a gambler. You want to be the casino. In this post, we explored one of these edges and some of the important variables to consider when trading this pattern. Are you interested in further education in order to shave years off your learning curve and countless hours of frustration? Check out https://www.swingtradesetups.com/plans-pricing