Pennants are powerful continuation patterns that often indicate a brief pause in a strong trend before the market resumes its previous direction. They are formed following a significant price move, known as the “flagpole,” which is characterized by a steep and rapid advance or decline. The pattern itself consists of converging trend lines—one sloping upwards and the other downwards—that form a symmetrical triangle. This consolidation phase represents a period of indecision in the market, where the buying and selling pressures are roughly balanced. Once this pause is over, the trend typically continues in the direction of the preceding move, making pennants highly valuable for traders looking to capitalize on ongoing trends. There are two primary types of pennants: the bullish pennant and the bearish pennant.
Bullish Pennant
Definition: A bullish pennant is a continuation pattern that forms in an uptrend. It occurs after a sharp rise in price (the flagpole), followed by a brief consolidation phase where the price action is bounded by two converging trend lines that resemble a small symmetrical triangle or pennant. The consolidation is a period of rest before the price breaks out to continue the upward movement.
Psychology: The formation of a bullish pennant reflects a temporary pause in a strong upward trend, often triggered by profit-taking or resistance. Despite this pause, the overall market sentiment remains bullish, as evidenced by the initial strong move upwards. Sellers try to capitalize on this by pushing the price down slightly, but they are unable to reverse the trend due to the underlying strength of the buyers. The narrowing of the pennant indicates that selling pressure is diminishing and buying pressure is building up. This period of consolidation allows traders to regroup and assess the market, leading to a breakout when buyers regain full control. The breakout typically occurs when the resistance line of the pennant is breached, signaling the continuation of the uptrend.
Entry and Profit Points: To effectively trade a bullish pennant, consider entering the market slightly above the resistance line of the pennant, as this signals a breakout and continuation of the uptrend. To calculate your profit target, measure the length of the flagpole (the distance of the initial sharp move) and apply this length upwards from the breakout point. This projection provides a reasonable estimate of the potential price move following the breakout, allowing traders to set realistic profit targets.
Figure: Trading a bullish pennant.
Bearish Pennant
Definition: A bearish pennant is a continuation pattern that forms in a downtrend. It appears after a steep decline in price (the flagpole), followed by a period of consolidation where the price action is confined within two converging trend lines that form a symmetrical triangle or pennant. The pattern signifies a temporary pause before the market resumes its downward movement.
Psychology: The formation of a bearish pennant reflects a momentary pause in a strong downward trend, often caused by short-covering or a support level. Despite this pause, the overall market sentiment remains bearish, as shown by the initial sharp move downwards. Buyers attempt to drive the price up slightly during the consolidation phase, but they lack sufficient strength to reverse the prevailing trend. The tightening of the pennant indicates that buying pressure is weakening, while selling pressure is building up. This period of consolidation provides traders with time to evaluate market conditions, leading to a breakout when sellers regain control. The breakout typically occurs when the support line of the pennant is breached, signaling the continuation of the downtrend.
Entry and Profit Points: To trade a bearish pennant effectively, consider entering the market slightly below the support line of the pennant, as this indicates a breakout and continuation of the downtrend. For your profit target, measure the length of the flagpole (the distance of the initial sharp move) and apply this length downwards from the breakout point. This projection helps estimate the potential price move following the breakout, allowing traders to set appropriate profit targets.
Figure: Trading a bearish pennant.
Key Considerations for Trading Pennants
- Volume Confirmation: Volume plays a crucial role in confirming pennant patterns. Typically, volume should decrease during the formation of the pennant, reflecting a lack of conviction among traders. However, a significant increase in volume upon the breakout is a strong indicator that the market is ready to continue in the direction of the prior trend.
- Timeframe: Pennants can form over different timeframes, ranging from minutes on intraday charts to weeks on daily charts. While the principles remain the same across timeframes, it’s essential to understand that patterns forming on higher timeframes generally indicate more significant moves than those on lower timeframes.
- Risk Management: As with any trading strategy, risk management is crucial when trading pennants. Traders should use stop-loss orders to protect against unexpected reversals or false breakouts. A common approach is to place the stop loss just outside the opposite side of the pennant from the entry point, ensuring minimal loss if the trade does not go as planned.
- Context Matters: While pennants are reliable continuation patterns, it’s important to consider the broader market context. Other technical indicators and patterns should be used in conjunction to confirm pennant breakouts and reduce the risk of false signals.
By understanding and effectively trading pennants, traders can take advantage of continuation patterns that provide high-probability trading opportunities in trending markets. Practicing these setups on historical data can help refine your skills and improve your ability to spot pennants in real-time trading situations.