A bearish flag follows a steep, or nearly vertical decline in price, and indicates a current downtrend may continue. The pattern consists of two parallel trendlines that form a rectangular flag shape. The flag can be horizontal, however, it often has a slight upward trend.
The vertical downtrend that precedes a flag may occur because of buyers’ reactions to an unfavorable company announcement, such as a court case, or a sudden and unexpected departure of a CEO. The sharp price decrease is sometimes referred to as the “flagpole” or “mast.”
The rectangular flag shape is the product of what technical analysts refer to as consolidation. Consolidation occurs when the price seems to bounce between an upper and lower price limit. This pattern formation reflects the reaction of sellers who are willing to sell at a lower cost, and the influx of buyers who inadvertently drive up the price as they compete to buy at the best possible price.
A bearish signal occurs when the price rebounds beyond the lower trendline of the flag formation, and continues the original downward price movement. This is considered a pattern confirmation.