Flags are diagonal contraction patterns with clear levels to trade against. Flags are actually one of the easiest patterns to play. They can occur at the end of a downtrend, and the end of an uptrend (bear flag into a blow off top), or in the middle of an existing trend (continuation).
When price breaks the structure in accordance with the pattern, it makes an immediate higher high where break out traders enter as (some) shorts cover. This energy usually produces a measured move, back to the high of the setup.
Flags are basically just patterns - not really entry setups - that you can easily recognise, and the break out confirms that price wants to move higher.
This is my #3 model, because I really consider it to be a pattern instead of an entry model. With patterns, you wait for price to arrive at the point of interest, and then use either model #1 or #2 to get long into the final decline. Some may call that the sniper entry, others would call it a knife catch, but when you get to a certain level of awareness, and through backtesting you can confirm, that where I take the model #1 or #2 entries in flags, is always the optimal trade entry, the single spot in the setup that offers by far superior risk/reward, and a good probability of succeeding. Models #1 and #2 can also be used to scalp the first lower high.
Breaking the 'knee' of the second correction is key, because that is the first time price breaks the structure with a higher high. If you look at flags, they are a sequence of lower lows and lower highs.
Let’s look at some examples and intricate detail.
Below is a simple flag structure. You can see that there is displacement in the downside moves, but the lower highs and lower lows overlap, which means that the higher timeframe doesn’t have any form of displacement. That is by definition a contraction.
The structure of a flag breaks down into two individual contraction patterns that are linked in the middle, while none of these sub structures makes a higher high.
This structure is the same each and every time, and looks exactly like this:
So now you can recognise flag patterns and understand their internal structure. Here is how I approach them, where I look for an entry, and where a directional break confirms: