Charting Asia

Published: Tuesday, 1 Sep 2009 | 2:28 AM ET

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Believe the chart or believe your heart? The rapid breakout with AIG from $14 to $30 set up a flag pattern.

The flag pattern is created with a combination of three features. The first is a flagpole. This develops over 1 to 5 days and includes very large price moves. The combined days rocket above the surrounding price activity and are clearly visible on the chart.

The second feature is a bullish flag. This is created when the price retreats from the peak of the flagpole. The retreat can be defined by two parallel down sloping trend lines. The lines do not converge. Converging lines develop a pennant pattern and it is traded differently. The sides of the flag are parallel and slope downwards. This is a bullish flag pattern. The lower corner of the flag should be no lower than 50 percent of the height of the original flagpole.

The third feature is the price breakout above the upper edge of the flag. This breakout is usually very rapid and powerful.

This pattern is used to calculate price targets. The height of the flagpole is measured and this value is projected upwards from the point where price breaks above the upper edge of the flag. This gives an exact price target, which has a high level of reliability. It’s one of my favorite trading patterns.

We use a strict definition, which improves the probability of success. Trading tactics for flag pattern are discussed in my book "Snapshot Trading."  This is precision pattern trading.

The flagpole was $16 high and the breakout target was calculated at near $41. This uses the price level where the price moved above the upper edge of the flag pattern. The run from near $25 to $41 kept the heart muscles pumping. Usually this flag pattern behavior develops a consolidation near the target projection level and this is a signal to exit the trade.

In very strong bull markets the flag pattern may continue and reach a second target level, which is twice the projection of the original breakout target. Even in bull market conditions this is an unusual event. The second projection target is near $56. This is calculated by taking the value of the first projection range and projecting it upwards from the top of that range.

In a market that is dominated by green shoots this double-target-momentum behavior   is the equivalent of weed killer.

Some weed killers operate by encouraging such excess growth that the weed literally grows itself to exhaustion. This the key concern with the chart pattern and behavior with AIG

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[AIG  Loading...      ()   ]. This type of momentum trend is unsustainable in the long term. For traders who hold the position the protect profit signals have already been delivered with the retreat from the second price target level at $56.

The remaining key questions revolve around the extent and the nature of the price retreat. It is usual to see some consolidation develop around the first target level prior to a continuation of the momentum. This has not happened with AIG. There is no consolidation  or pause  in momentum near $41. This suggests that any price retreat is unlikely to find support at this level.

AIG developed a small consolidation behavior near $340. This consolidation behavior identifies a potential support area from the retracement from $56. Traders will not buy as soon as price nears this level. Cautious traders will wait to see evidence the support level can hold. When they also see evidence of a rebound it provides a buying opportunity with an initial target near $41 and higher.

Generally a flag pattern momentum will collapse back to an underlying long-term trend. The potential for this trend can be defined with the trend line starting from the $13 low and touching the lows near $23 that were the starting point for the most recent momentum move. This is a tentative trend line. The position of the line remains to be proven by a price retreat to the line followed by a rebound. A fast retreat will drop price towards the consolidation area round $34 where it may also find potential support from the trend line.

Failure to hold at this combined support feature gives a downside target near $28, which is near to the peak of the flagpole breakout. Flag patterns show momentum continuation, but they do not inevitably show trend continuation. It is the nature of the pullback and rebound that will define the strength and character of the long-term trend in AIG.

Until then, AIG is a traders stock so believe the chart and not your heart which longs for a stock price with three figures.

If you would like Daryl to chart a specific stock, commodity or currency, please write to us at . We welcome all questions, comments and requests.

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