Investor Education: The High, Tight Flag: Rarely Seen Pattern, But Run-Ups Are B

High, tight flags are most often found in small, thinly traded stocks that explode after wallowing in obscurity. Something drastic is happening, and the market is scrambling to price in this new landscape.

The first stage of a high, tight flag is a jump of 100% or more in four to eight weeks. That's the high part.

Stage 2 is a correction of three or four weeks. The stock should retreat no more than 20%. That's the flag's tight pennant.

Stage 3 is a burst from that pennant. Such a burst can lead to gains of 200% or more, O'Neil says.

Stun gun maker Taser International (NasdaqGS: - ) stunned the market in 2003-04 with a move that turned a thinly traded small cap into one of the hottest stocks of the time.

Taser's earnings in the three most recent quarters at that time surged 167%, 400% and 999%. Sales gains accelerated 43%, 53% and 217%.

Taser also carried an Earnings Per Share Rating of 81, a Relative Strength Rating of 99 and an Accumulation/Distribution Rating of A.

Yet many analysts were amazed that anyone would buy this stock, with its 189 P-E ratio. Perhaps they didn't see the high, tight flag.

The Base

You had to act fast if you wanted to buy Taser. The stock started to move up in March 2003 from a split-adjusted 0.35 (or 4.20 pre-split) (point 1).

It didn't touch its 10-week moving average until Sept. 29, 2003, at 2.08 (point 2). Until that point, there wasn't a single base over 10 (0.80 pre-split on the accompanying charts).

What's more, Taser wouldn't again touch its 10-week line until the party was over.

The Run-Up

Buying the pullback at 2.08 would have been the trade of a lifetime. The stock blasted right past its previous high of 2.70 (point 3). But a look at the daily chart showed some unhealthy volume patterns.

Taser moved on to 5.78 (point 4) in the week ended Oct. 31. It paused a few weeks to consolidate its gains.

Note a sort of pennant in the ensuing two weeks. Was this a high, tight flag? No. Be careful. This pennant was too short and sloppy -- Taser corrected 26% from its 5.78 peak.

Taser then shot ahead. Note the push to 7.79 in the week ended Dec. 12, 2003 (point 5).The stock consolidated for nearly four weeks. In the process, it backed off to 6.53 (point 6), just 16% off its high. This satisfied the requirements of Stage 2.

Taser took out its previous high in the Jan. 9, 2004, week. That was the breakout from a high, tight flag (point 7). The stock soared for the next 31/2 months to 32.07 in the week ended March 23 (point 8). That's a 311% profit from the breakout.

The Top

Taser's first clue it was in trouble was that March 23 week. After notching that new high, it turned tail to close 29% lower than the previous week. Volume exploded to a record 177.5 million shares (point 9).

It's not a coincidence that the wild move occurred the same week as a 2-for-1 stock split. Taser effected a 3-for-1 split just nine weeks earlier and would deliver another 2-for-1 in December.

Those are too many splits. The result was a rush of too many new shares on the market. The stock broke its 10-week line after the second split. By the time it bottomed in June (point 10), it had crashed 63%.