What is a Pennant Pattern?
In the trading world, a pennant is a continuation pattern formed when security undergoes a large-scale movement followed by a consolidation period with converging lines. The first phase is known as a flagpole in technical analysis. However, what separates a pennant from a flagpole is the period of consolidation that follows after the large movement. In a pennant, one can observe, in the same direction as the first significant movement, a breakout movement that represents the second half of the flagpole. It completes the pennant chart pattern.
Key Characteristics
When trying to identify a pennant pattern in trading, you will see the following three movements.
Phase 1 – First Flagpole
This is always the start of a pennant pattern. This also differentiates a pennant pattern from other technical indicators, such as a symmetrical triangle. This upward rise denotes the influx of volume and rises in stock price, which precedes the pennant.
Phase 2 – Pennant Pattern
Coming to the pennant itself, one should observe a triangular shape after the period of consolidation is over. Two converging trend lines should come together to form a triangle, which is the pennant.
Phase 3 – Breakout levels
In the case of the pennant, there will be not one but two separate breakouts. One will be at the end of the flagpole itself, and the other will be after the consolidation period preceding the flagpole. Breakouts could be upwards or downward but will continue the trend in one direction.
How can I spot a pennant formation?
In terms of structure, pennants are similar to flags. Both have converged lines that last between one to three weeks in their consolidation period. However, looking at the trade volume to spot a pennant pattern is crucial. During the initial move, the trade will see a lot of influx of books. This will follow with a period of weakening volume, characteristic of the pennant formation. Finally, there will be another significant increase in volume, signifying a breakout.
As shown in the image above, the flagpole shows the previous trend as higher. Then pennant formation is observed when the volume reduces as there is a period of consolidation. During this period, traders are anticipating a breakout period. That breakout period is when the upper trendline forms a symmetrical triangle.
How to trade with pennant pattern technical analysis?
Pennant trading is about spotting the formation and correctly anticipating the breakout point. Following the breakout from a pennant, most traders seek to enter short or long positions. For instance, a pennant trader might observe a bullish pennant forming. Accordingly, she might limit the buying order above the pennant’s upper trendline. Once the security breaks out of this upper trendline, the trader might look for an above-average volume that confirms the pennant pattern. Once an influx of volume is seen, pennant formation is confirmed, and she can hold her position until the security reaches her target price.
Usually, for pennants, the target price is often established by applying the flagpole’s height to the point at which the share’s price exceeds -breaks out of the pennant. For example, suppose that the stock price rises from ₹50 to ₹100 due to a sharp rally. Then the stock price consolidates to ₹85 and finally breaks out of the pennant at ₹90. A trader who wishes to use pennant pattern technical analysis in their trade will look for a target price of ₹50 plus ₹90 equaling ₹140. Accordingly, traders set the stop loss at the pennant chart pattern’s lowest point. A breakdown from these low levels would invalidate the pattern and could mark the start of a long-term reversal in the price.
Traders also often use the pennant pattern technical analysis with other chart patterns. It is difficult to confirm whether what one sees is a pennant, but other indicators can help validate one’s assessment. For example, using a relative strength index or RSI allows one to wait for these levels to moderate in the consolidation phase. It leads to a potentially higher move. In another scenario, the price consolidation may occur close to the trendline’s resistance levels. From here, a breakout could create a whole new support level.
Time Frame for a Pennant Pattern
A pennant pattern is a short-term pattern that generally forms over days or weeks. It is not uncommon for traders to trade on pennant patterns that appear in longer time frames.
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