This chart pattern as the name suggests resembles a flag on a pole. This pattern is a continuation pattern which suggests the initial price trend will continue.
This formation occurs after a sharp up or down move in the prices. After such a big price move (up or down) the share price takes a break before continuing the initial trend. This break normally takes the form of a rectangle and as such called the 'Flag' and the sharp price movement (up or down) preceding the Flag is considered to be the 'Pole'. For you to consider a Flag to be present in a stock chart the Pole should definitely be present.
The Flag or the rectangle is made up of two trend lines that act as support and resistance for the price of the stock until the price breaks through the Flag. Generally, the Flag will not be flat but will be either downward or upward sloping. The slope of the Flag should be the opposite of the previous trend (i.e. the slope of the Pole). If the initial sharp price movement was trending upward, the slope of the Flag will be downward and vice versa.
Let's see what it looks like graphically:
As you can see from the chart above, there are a number of price movements within the flag but these trades are on lower volume. After this quiet period (or after the Flag) the price will break out of the flag and will continue in the direction of the previous sharp price move that occurred before entering the Flag. This breakout will be on higher price and volume. The pattern is complete when the price breaks out in the direction of the initial price movement.
If you are observing a Flag in an upward stock chart (i.e. the price movement prior to the breather was uptrend) the BUY signal is triggered at the point the price breaks out from the Flag.
On the other hand, if the Flag is in a downward stock chart the SELL signal is triggered when the price breaches the upper level of the Flag.
This pattern is considered to be one of the most reliable chart patterns and almost always results in a continuation of the initial trend. However, care must be taken in identifying the Flag correctly as the reliability of the formation depends on correct identification