This forex scalping strategy has a much higher probability of success in terms of trades hitting their take profit levels because of the sheer amount of strength vs resistance with a 1 : 1 risk to reward ratio.[/TS_VCSC_Info_Notice]
The Flag Formation (FF) Trade is one of my personal favourite as it lets you run the trade for a long time to come and can even bag you 25+ pips. It is a 1 : 1 risk : reward strategy where you typically risk 25 pips to bag 25 pips of profit.
As the name suggests, the first requirement of a Flag Formation (FF) Trade is there to be a flag formation setup formed. Here’s the concept behind why this strategy is so powerful :
Case Study (AUDUSD)
If you look at the pictures above, for the bullish flag on the left (AUDUSD), you can see that there is so much support (blue boxes and green diamonds) vs an almost empty opposition (very little orange boxes). Based on pure simple mathematics, if price were right in the middle, which direction do you think you would stand a higher chance of winning? Bullish upward move or bearish downward move?
Defining your “edge”
If your answer is Bullish upward move, you’re correct. Price has to go through a whole load of support (blue boxes and green diamonds) which are all crazy strong and you can bet it will face difficulties even if it tries. On the other hand, because there is so little resistance above it and if it wanted to head there, it could easily walk right through. So, this simple fact represents your “edge” in the market. You have an “edge” on being bullish in this scenario because you’re able to accurately identify all the support and resistance levels across 9 time frames and trade in the direction that has the least resistance (referring to the AUDUSD example).
Still sticking to this example : Now, assuming we do the most simple risk : reward 1 : 1 trade where we risk 25 pips vs target 25 pips of reward. What is the likely outcome of such a trade? For a casino, they’re able to be one of the most profitable businesses on the planet with often less than a 2% edge (51% reward vs 49% risk). Over the long run based on the law of large numbers, they ALWAYS end up profitable because of that 2% edge.
In this example, based on a very simple understanding, we already have an edge (because of all the blue boxes and green diamonds of support in our favour), and the edge is not 1%, nor 2%, instead it is around a 40% edge (70% reward vs 30% risk) based on past trading records. So if a casino can make a fortune with a 2% edge, what then can we do with a 30% edge? Well, we can make incredible fortunes then! Another way of seeing this is if we take each green diamond and each light blue/ dark blue fibonacci box as 1 soldier for the bullish army, and we take each light/dark orange fibonacci box as 1 soldier for the bearish army – which army looks stronger now? It looks like 70 bullish soldiers vs 10+ bearish soldiers and you definitely want to be on the side of the bullish army when taking a trade.
Law Of Large Numbers
Importantly, I need to stress that a casino wins because of “law of large numbers”, meaning they can play their 2% edge enough times to make it count. If they only allowed 1 gambler to play once and bet their entire business on it, they would have a 49% change of losing (vs 51% chance of winning) right? That means they have a 2% edge and it’s too risky. Now, if they repeated it 100 times, what is their edge? 2% x 100 = 200%. And that’s how a casino wins in the long run – law of large numbers.
With the law of large numbers being the key to milking this 30% edge we have for success, we need to ensure we’re able to do the same thing. How? Simple, by not overcommiting on every trade. Risking 0.25% to 0.50% of your account on every trade is the perfect way to do this . Even if you astonishingly lose 20 trades in a row (which has never happened in my time in trading this strategy), you’ll only be down 5%. The important thing is to keep trading and over time, you’ll see the 30% edge work in your favour.
Entry and Stop Loss
The key to entering into such trades is not to enter right at the very top (for bullish flag formations) nor the very bottom (for bearish flag formations). Instead, we look to buy on weakness, sell on strength. This means for bullish flag formations, we look for price to drop a bit first before buying (observe the light blue entry zones seen above). The same goes for bearish flag formations, we look for price to rise a bit first before selling.
In terms of the stop loss, a good figure to use it roughly 25 pips, however, a more accurate figure would be to “eyeball” the chart and find where the most concentrated portion of the flag ends and set that as your stop loss. In the examples above, for GBPUSD, you can see that most of the flag ends at around the 57 level, so we set that as our stop loss. Similarly for USDJPY, most of the flag strength ends at near the 98 level, so we set that as our stop loss.
Risk to Reward Ratio
A healthy risk to reward ratio is anywhere from 1 : 1 to 1 : 1.5. Both are equally fine when trading this strategy. The reason why we have such a small conservative risk to reward target is because as price moves, the flag formation changes and we run the risk of the flag slowly weakening over time. The goal is the ride the flag formation when it is as its strongest and bag all the pips we can during that period.
Continue Your Education
Now that you’re done with this tutorial on the flag formation, head back to our guide on forex scalping strategies to learn the other strategies we have.