Step one:
Create a new document with the dimensions of 50w x 50h pixels and resolution of 72ppi. Using the marquee selection tool, drag a rectangle in the center of the image like the one in the example. Select blue as your foreground color and press Alt-Backspace/Option-Backspace to fill in the selection. Press Ctrl-D/Command-D to deselect.

Step two:
Press D (resets foreground to black and background to white), then select the Linear Gradient tool and make sure it is set to "Foreground to Background." Press Q to enter Quick Mask mode and drag the gradient tool across the image to get something similar to the example-left (red-shaded gradient). Press Q again to exit quick mask mode. You should have a selection like the figure left (You may need to inverse the selection depending on what your quick mask settings were. Press Shift-Ctrl-I/Shift-Command-I if this is the case.) Go to Select > Save Selection, type the name "Wind" and click OK. Now that the mask is made, save the file and jump over to ImageReady

Step three:
Once you're in ImageReady press Ctrl-J/Command-J 3 times to create 3 copies of the blue rectangle. Click on the bottom-most layer and go to Select > Load Selection > Wind. Click on the eye icons beside the remaining layers above to hide them.

Step four:
Go to Filter > Distort > Wave. If you haven't used this filter before, you'll be surprised by all the settings to it. You can either follow the list below or look at the screen-shot to the left:
Type: Sine
Number of Generators: 1
Wavelength: Min. 10; Max. 20
Amplitude: 5; 6
Scale: Horiz. 45%; Vert. 61%
Undefined Areas: Repeat Edge Pixels
Click OK when you are finished. The gradient mask we saved in Photoshop prevents the left side of the flag (where it meets the pole) from being distorted.

Step five:
Select the second layer up and hide the bottom-most one so you can see the rectangle better. Press Alt-Ctrl-F/Option-Command-F to bring up the Wave filter dialog box again. All you have to do here is click the button labeled Randomize. Actually, you can click it a couple of times till you see enough difference in the rectangle from the one before. Repeat these same steps for the top two layers (Randomize Wave filter).

Step six:
Now here's the easy part: From the animation palette pop-out menu, select Make Frames From Layers. Press the play button on the buttom of the animation palette to see the animation.

Step seven:
Sometimes the frames may not always be so smooth. In my case, the first and last frame are a little too similar. You can see how it has a slight jump in the animation in the previous step. I just simply delete the last frame. Apparently 3 frames was all I needed in this case.

Step eight:
Create a new layer and drag it below all the others. Select the line tool and choose a bright red shade. Drag a line with a weight/thickness of 3 pixels down the left side of the flag. You may need to choose Match Layer Across Frames from the animation palette to keep the pole consistent across all the frames. I added a slight bevel to my frame.

Step nine:
If you want to do a flag with text, you can create 4 duplicate layers of the text above the flag duplicates. After you apply the the wave filter to the first layer, select the first text layer and press Ctrl-F/Command-F to apply the exact same wave settings to the text. Then, select the next rectangle and use the Randomize setting from the wave filter. Select the next duplicate of text and press Ctrl-F/Command-F to apply those settings of the wave filter to the text, and so on, and so on.

Step ten:
Create a new frame in the animation palette for each matching wavy rectangle to its text (first layer rectangle to first layer text, second layer rectangle to second layer...you get the picture). And there you have it! You will have to experiment with the Randomize feature of the wave filter to get your best results. Don't forget, if your animation ends up looking blocky, you can always drag and move the frames around until you get your satisfactory windy flag.