In security markets, observing a sharp movement in the price followed by periods of consolidation is a common occurrence. But, determining whether the consolidation will be followed by a continuation of the initial price movement or by a reversal of it is a bit more of a challenge. This is where Pennant Pattern and several other chart patterns, in the same pattern category, come into play.
What is the Pennant Pattern? A Pennant Pattern is a continuation chart pattern that frequently forms on the price chart of various securities. It consists of a pole, which represents a high momentum move in security’s price, a Pennant, which is similar to a symmetrical triangle in appearance and represents a consolidation, and a price continuation in the direction of the original trend or the pole.
Within the realm of chart patterns, the Pennant Pattern is categorized as a continuation pattern because, at the end of the pattern, the price of the asset assumes the direction of the prevalent trend. But, how does a pennant pattern work? How can it be identified? What is the difference between this pattern and other patterns similar to it? The answers to all of these questions and more will be discussed in the remainder of this article.
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Table of Contents
Types of Pennant Pattern
Similar to most other chart patterns, there are two types of pennant patterns. These are –
- Bullish Pennant Pattern
- Bearish pennant Pattern
Now, let us briefly discuss both these types and understand how one type differs from the other.
Bullish Pennant Pattern
“Bullish” is a trading term used to refer to a market where there is an uptrend in the price of the asset. A Bullish Pennant, therefore, is a continuation pattern that occurs during a strong uptrend and signals the continuation of this uptrend at the end of the pattern.
At the beginning of the Pennant, an upward pole forms: this means there is a strong upward movement in price. This is then followed by a period of consolidation, the “Pennant,” and then finally a renewed bullish momentum afterward. Traders usually look for the breakout above the Pennant, leading into the continued uptrend in price to make a profit on.
Bearish Pennant Pattern
The term “Bearish”, on the other hand, refers to a downtrend in a market, or a market where the prices are declining. Therefore, a Bearish Pennant is a downward trending continuation pattern that occurs after a strong downtrend and signals this downtrend’s continuation at the end of the pattern. Essentially, the Bearish Pennant is the opposite of the Bullish Pennant.
At the beginning of the Bearish Pennant, a downward pole forms, that is, a strong decline in price. This is then followed by a period of consolidation, called the “Pennant,” and finally the bearish decline continues. In the case of a Bearish Pennant, traders look to enter short or short-sell trades on the breakout that occurs below the Pennant.
Identifying Pennant Pattern
The Pennant Pattern bears some similarities to other chart pattern types, such as the Triangle Chart pattern and the Flag Chart Pattern. (The differences between these are explained further below.) But an essential thing to note is that while Pennant Pattern can be confusing, it can be easily identified and differentiated from all other trading chart patterns by its structure.
There are two ways to correctly identify and to confirm the formation of a Pennant Pattern –
- With Geometry and Shape Recognition
- With the Use of Technical Indicators and Tools
In the following sections, let us briefly go over both these approaches, so that you never experience issues in identifying a Pennant Pattern. For the highest accuracy, I would strongly recommend that you leverage both these approaches towards identifying the Pennant Patterns in combination with each other.
Identifying Pennant Pattern Using Geometry and Shape Recognition
Structurally, a complete Pennant Pattern comprises three main components, with each component having its own unique identifiable characteristics. These components are –
- Pole: The pattern is always initiated with a strong, or high volume, movement in price, which is called a Pole. This pole is characteristic to the Pennant Pattern and singles it out from several other chart patterns that are similar to it in appearance.
- Pennant: After the strong price movement, or Pole, comes the period of consolidation. During this phase, the price of the security fluctuates up and down, but in essence, it remains bounded within a converging range. If two straight lines, the Support and the Resistance, are traced from the top to the bottom of these converging points, you will notice a symmetrical triangle. This is the Pennant, which is the namesake of this chart pattern.
- Breakout Region: In its final leg, the Pennant Pattern comprises another strong price movement that breaks out of the Pennant formed during the consolidation period. In the case of a true Pennant Pattern, this strong movement in price trend is always in the direction of the prevailing earlier trend, or the Pole.
Identifying Pennant Pattern Using Technical Indicators and Tools
Generally speaking, the Pennant Pattern does not require any technical indicators to be identified. However, there are several tools and concepts in technical analysis that you can use to confirm the formation of this pattern.
Listed below are the most effective concepts and tools in technical analysis that you can leverage to confirm the formation of Pennant Patterns –
- Volume: Variation in trading volume during the three development phases of the pattern can be used as a strong confirmation signal in identifying the Pennant Pattern. The initial trend, or the Pole, of the pattern, is marked by a high volume phase. Post this initial phase, during the consolidation phase that results in the development of the Pennant, the trading volume is extremely low. Finally, in the final leg of the pattern, once the price breaks out of the Pennant structure, there is a big surge in trading volume again. Hence, when identifying the Pennant Pattern on the price chart of a security, you can leverage volume readings from technical indicators, such as – ADX (Average Directional Index), On-Balance Volume Indicator (OBV), etc., as signs of confirmation.
- Moving Averages: The Moving Average Line Indicators are perhaps the simplest of all technical indicators that exist today. Yet, moving average lines are very powerful in determining the direction of the trend. Hence, you can use this indicator to confirm the formation of the Pole, when identifying the Pennant Pattern. In terms of indicator settings, a 50-day or higher moving average line will work well, in most trading scenarios, for this purpose.
- Price Action Structures: These are simple chart structures such as the trendlines. As discussed in earlier sections, the Pennant Pattern has very unique characteristics and is composed of three distinguishable price movement phases. Hence, when identifying the Pennant Patterns, the Price Action Structures can very effectively provide a visual confirmation on pattern formation.
Differences Between Pennant Pattern and Triangle Pattern
Now that we have covered various methods to identify the Pennant Pattern, let us discuss the key differences between it and the Triangle Pattern. By appearance, the Pennant looks very similar to a Symmetrical Triangle, hence differentiating between the two patterns is critical for your trading accuracy.
When trading this pattern, to differentiate between the Pennant Pattern and the Triangle Pattern, you can look for the following key differences:
- The Pole: A Pennant Pattern must be preceded by a strong movement or change in the price movement, which is commonly referred to as the pole. If there is no pole, then it is simply not a Pennant Pattern, and it could be a Triangle Pattern.
- Level of retracement: With a Pennant Pattern, usually, the price movement does not retrace very much of the change that occurred during the development of pole. That is to say that the retracement level of the Pennant Pattern is shallow; it could be equal to about 38% of the price change during the formation of the pole. A deeper retracement generally indicates a Triangle Pattern instead of a Pennant.
- Continuation: A Pennant is characterized by a continuation of the initial uptrend or downtrend. However, the same is not true for a Symmetrical Triangle. Instead, a Symmetrical Triangle Pattern can end with a price breakout in either direction.
- Time period: A Pennant Chart Pattern is regarded as a short-term pattern. It can occur within a period of one to three weeks. Triangle Patterns, on the other hand, can take a much more extended period to form.
Difference Between Pennant Pattern and Flag Pattern
The Flag Pattern is another chart pattern that traders often confuse with the Pennant Pattern. The differences between the Pennant Pattern and the Flag Pattern are not numerous, as they are quite similar to each other. They both have the pole, which precedes the rest of the chart pattern. But even for these two patterns, you can look for the following key differences:
- The shapes of trendlines across the middle sections: This is the main difference between the Pennant Pattern and the Flag pattern. As mentioned above, in the case of a Pennant Pattern, when two trendlines are drawn across the tops and bottoms of the peaks and troughs of the consolidation period, a triangle shape is formed and the two lines as they appear to be converging together. The same is not true for a Flag Pattern.
- For the Flag Pattern, the trendlines will not converge at all: These same two trendlines, when drawn for the consolidation period of the Flag Pattern, will remain parallel to each other. This creates a structure that resembles the shape of a flag on the price chart, after which, this pattern type is named.
Interpreting Pennant Pattern
The market psychology behind the Pennant Pattern is quite simple. Following a sharp movement in the price of a security, either an increase or a decrease, it is natural for many traders to assume that a reversal is coming. Consequently, these traders move to liquidate their open positions and book profits.
As this is occurring, there are traders on the other side of the market, who are seeking to open trading positions in the direction of this new trend. These traders believe that the newly developed trend, which is represented by the Pole, is not yet over and any counter-trend movement in security’s price is merely a pullback before this trend continues.
These opposite forces result in consolidation, which is marked by a back and forth movement in security’s price. As these forces get closer to a balance, the movement closes in and becomes shorter and shorter, leading to the formation of the Pennant. As time goes on, this Pennant can be traced using two converging lines and takes a shape that is similar to a symmetrical triangle in appearance.
Once the balance is broken between the buyers and the sellers, and the bids and the offers, the market will either complete the Pennant Formation by breaking the opposite edge (of the pennant), leading to the price continuing in its original direction, which is the direction of the pole.
Improving Reliability of Pennant Pattern in Trading
Most technical traders count Pennants among the most reliable chart patterns. It is relatively easy to trade using Pennants, and the pattern is known to provide highly reliable trading signals. However, the reliability of the Pennant Pattern can be further enhanced by using it in combination with other complementary trading methods and technical indicators.
Several technical indicators and technical analysis concepts that can be used to enhance the reliability of the Pennant Pattern are as follows:
- Japanese Candlestick Patterns
- Harmonic Patterns
- Moving Averages, Momentum Indicators, and Divergence
Now, let us briefly discuss how each of these above-listed tools can help with enhancing the reliability of the Pennant Pattern.
Japanese Candlestick Patterns
Candlestick Patterns are among the most popular trading tools in various technical trading circles. These patterns are often classified into two main buckets – the Reversal Candlestick Patterns and the Continuation Candlestick Patterns. Indecision Candlestick Patterns is another classification for these patterns, but many traders tend to consider them as a sub-category within the Reversal Candlestick Patterns.
With trading Pennant Patterns, depending on the type of trading position that you are looking to enter, various Candlestick Patterns can come in very handy in providing the trade confirmation signals.
- If you plan on taking a breakout trade using the Pennant Pattern, you would leverage the Continuation Candlestick Patterns to confirm that that price will continue its new established trajectory post-breakout.
- Similarly, when trading the internal wave structure of a Pennant, the Reversal Candlestick Patterns can provide confirmation signals on potential reversal points.
Hence, the reliability of trades made using the Pennant Pattern can be significantly improved when you confirm your trade entries using confirmation signals from the Japanese Candlestick Patterns.
Harmonic Patterns
Harmonic Patterns are great at providing a forecast on the upcoming waves on the price chart of a security. Hence, when trading Harmonic Patterns, you already have a good sense of direction in which the price is expected to move.
By combining this directional bias offered by the Harmonic Patterns with the trading signals from the Pennant Patterns, the reliability, or the success probability, of your trades can be further enhanced.
There are many different Harmonic Patterns that technical traders use in combination with the Pennant Pattern. Popular examples of some of these widely used Harmonic Patterns include the following –
- Gartley Pattern
- Bat Pattern
- Crab Pattern
- Shark Pattern
Moving Averages, Momentum Indicators, and Divergence
Moving Average, Momentum, and Divergence are great tools to gauge the strength of a trend. Hence, when used in combination with the Pennant Pattern, these insights can significantly boost the success probability of your trades.
Personally, when trading the Pennant Pattern, I always look for divergence on the price chart to confirm my directional bias for the trade.
To gather insights on Divergence and Momentum, there are numerous different technical indicators that you can leverage in trading. Popular examples of these indicators include –
- The Relative Strength Index (RSI): The RSI is a momentum oscillator that provides insights into the strength of a trend. It is a relatively easy to use indicator that simply comprises a signal line that oscillates on a scale of zero (0) to hundred (100). On the RSI scale, a reading above the 70 mark, signals that the asset is overbought. Similarly, a reading below the 30 mark on the indicator scale indicates an oversold condition. Additionally, when the RSI readings and the actual price action show misaligned trends, the condition is referred to as Divergence. When used and interpreted correctly, Divergence can come in very handy at identifying the potential points of reversal.
- On Balance Volume (OBV): The OBV provides a running total of an asset’s trading volume and compiles a lot of volume information into a single line indicator. It also shows whether the trading volume is flowing in or out, and therefore provides meaningful insights on the momentum of a trend.
Trading Pennant Pattern
Now that we have discussed various methods to identify the Pennant Pattern and understand the market psychology behind its formation, let us get straight to the business and discuss how one can trade the financial markets using this pattern.
To trade the Pennant Pattern, there are two easy strategies that you can incorporate into your overall trading plan. These are –
- Pennant Pattern Breakout Trading Strategy
- Pennant Pattern Retest Trading Strategy
Both these strategies can be applied to Bullish, as well as, Bearish Pennant Patterns.
In the case of a Bullish Pennant Pattern, you will trade with a bias towards entering a long trade. Contrarily, when trading the Bearish Pennant Pattern, your bias will be to sell or short-sell the security.
Now, without further ado, let us briefly discuss both these strategies so that you can incorporate them with confidence into your overall trading plan.
Trading Strategy-1: Pennant Pattern Breakout Trading Strategy
The Breakout Trading Strategy is perhaps the most common strategy that technical traders use for trading the Pennant Pattern.
There are four main stages to trading the Pennant Pattern using the Breakout Strategy. These are –
- Identifying Tradable Wave
- Determining Trade Entry
- Determining Stop Loss Target
- Determining Take Profit Target
In the following sections, we will briefly discuss each of these four stages.
Identifying Tradable Wave
With Breakout Trading Strategy, your goal is to trade the final leg of the Pennant Pattern. This is the price wave that initiates once the consolidation phase, or the Pennant, of the pattern, is complete.
- In the case of a Bullish Pennant Pattern, you look for a breakout trade above the Pennant.
- Contrarily, when trading a Bearing Pennant Pattern, you would look for breakout trades below the Pennant, or price consolidation.
Determining Trade Entry
In this strategy, you will look to enter the trade once there is a confirmation of a breakout at the end of the Pennant or the consolidation phase.
- With a Bullish Pennant Pattern, a sharp movement in the price above the pennant is an indication that there will be a breakout and a continuation of the uptrend. Therefore, you will enter a buy trade when a sharp price move breaks through the resistance line of the Pennant, and you get some form of a trend continuation signal using a complementary analysis method. Japanese Candlestick Patterns provide strong confirmation signals for such trades.
- Similarly, in the case of a Bearish Pennant Pattern, you are looking for a breakout below the Pennant. Therefore, a sharp price move that breaks through the support line of the Pennant serves as the first indication for a potential bearish trade entry with this strategy. Once you get such a price move, wait for a continuation confirmation signal and short-sell that asset that you are trading.
Determining Stop Loss Target
Stop loss targets for this strategy can vary based on your risk appetite and your trading methodology.
- Setting the stop loss at the opposing edge of the Pennant preceding the breakout is one option. With this approach, in the case of a bullish trade your stop loss will be placed a few points below the support line of the Pennant. Similarly, when trading a Bearish Pennant Pattern, you will place your stop loss a few points above the resistance line of the pattern.
- Alternatively, stop loss can be placed at the bottom or the top of the Pennant formation. With this approach, when trading a Bullish Pennant, you will place the stop loss for your trade a few points below the bottom of the Pennant. Similarly, in the case of a bearish trade, your stop loss will be placed a few points above the top of the Pennant formation.
When choosing the opposing edge of the Pennant, you will select a price point below at the lowest part of the consolidation preceding the breakout of the Bullish Pennant. Similarly, a price point above the top of the consolidation will need to be chosen as the stop loss when trading a Bearish Pennant.
Determining Take Profit Target
With this strategy, the general rule of thumb for determining the take-profit target is that the price will move a distance equal to the gap made by the original breakout (or the Pole) that preceded the Pennant, or the consolidation.
Hence, in order to determine the take profit targets for your trades, you can use the following guidelines –
- When trading a Bullish Pennant, you will take the distance covered by the Pole and add it to the breakout price point of the Pennant.
- Similarly, in the case of a Bearish Pennant, you will take the distance covered by the Pole and subtract it from the breakout price point of the consolidation.
Trading Strategy-2: Pennant Pattern Retest Trading Strategy
Retest Trading Strategy is the other popular way to trade the Pennant Pattern. In essence, this strategy is very similar to the Breakout Trading Strategy, and many traders consider it merely an extension of the Breakout Strategy.
Just as with the Breakout Trading Strategy, there are four stages to trading the Pennant Pattern using the Retest Trading Strategy. These are –
- Identifying Tradable Wave
- Determining Trade Entry
- Determining Stop Loss Target
- Determining Take Profit Target
Now, without further ado, let us discuss each of these four stages.
Identifying Tradable Wave
In the Retest Trading Strategy, similar to the Breakout Trading Strategy, the price wave that we target to trade is the final wave of the Pennant Pattern. Hence, even with the Retest Strategy, you will wait for the price wave that originates after the consolidation phase, or the Pennant formation, is over.
- When trading a Bullish Pennant Pattern, you look for a long or a bullish trade entry above the Pennant with this strategy.
- Similarly, in the case of a Bearish Pennant Pattern, you will look for a short or short-sell trade entry below the Pennant.
Determining Trade Entry
In this strategy, instead of taking a trade directly after the breakout, you wait for a retest to occur instead. In essence, this a more conservative approach to trading the Pennant Pattern, and is more suitable for risk-averse traders. This is because, when trading this strategy, you are better protected against fake-outs or false breakouts, which are not very uncommon.
A retest refers to the price reversing its direction after a breakout and returning to the breakout level. Many traders assume that if this movement occurs, then it is a strong indication that the breakout will hold.
- With this strategy, for both bullish and bearish trade entries, you will need to find the potential retest point after the breakout on the price chart has occurred. This retest point, once identified, then becomes your trade entrance.
Determining Stop Loss Target
The stop loss target for this strategy will be placed at the opposing edge of the pennant. Hence, you can determine the stop loss targets for your trades using the following guidelines –
- In this strategy, when trading a Bullish Pennant, the stop loss for your trade will be placed below the support line of the Pennant, at the breakout point.
- Similarly, when trading a Bearish Pennant with this strategy, you will place the stop loss for your trade above the resistance line of the Pennant, at the breakout point.
Determining Take Profit Target
The take profit targets for this strategy are determined the same way as you would identify them under the breakout strategy explained above. These are –
- With a Bullish Pennant, you will measure the length of the initial, or the first, wave of the Pennant Pattern that came in before the consolidation, and add that distance to the breakout point. The price point that you get post this addition will be the take profit target for your trade.
- Similarly, when trading a Bearish Pennant, you will measure the same length, and subtract that distance from the breakout point to set the take profit target for your trade.
Advantages and Limitations of Trading Pennant Pattern
Just as with any other chart pattern, there are several advantages and limitations of trading the Pennant Pattern. To best incorporate this chart pattern into your trading strategy, it is important that you understand and account for these advantages and limitations in your trading plan.
Therefore, in the following sections, we will discuss some of the most important strengths and weaknesses of the Pennant Pattern. Knowing these will empower you to make more informed trading decisions around these formations.
Advantages of Trading Pennant Pattern
The key advantages of trading the Pennant Pattern include the following –
- No Technical Indicators are required to trade this pattern. While some traders will still employ and use certain indicators, such as the ones mentioned above, to help validate this pattern, it is still possible to identify it without the use of them.
- As a continuation pattern, it offers opportunities to enter the trade within the environments that are still trending and not after the fact.
- The Pennant Pattern forms on all timeframes, and therefore, it is usable by a diverse group of traders to make a profit from. For example – day traders and longer-term position traders.
- Generally, the risk/reward ratio for Pennant Pattern trades is low at about 1:3. So, it is an ideal choice for traders with a diverse risk profile. Even those who are a bit more risk-averse can therefore fall in love with this pattern.
- The pattern has relatively objective trading rules that are simple to follow.
Limitations of Trading Pennant Pattern
The key limitations of trading the Pennant Pattern include the following –
- These patterns are challenging for traders who do not have a certain level of trading experience because the price is continuously evolving.
- Just like any other chart pattern, this pattern is not always successful, and thus can lead to losses. Therefore, even though the Pennant Pattern offers a great risk/reward ratio, traders still need to be aware that there are risks involved with trading this pattern.
- Although Pennant Patterns are continuation patterns, they can sometimes fail and result in a reversal in the price trend as opposed to a continuation. So, it is crucial to apply some proper trading and risk management techniques when trading this chart pattern.
- While the price pattern is still unfolding, it can be extremely challenging to identify a Pennant Pattern. They are simple to identify in hindsight, but that is of little value as by then the profit opportunity may have already passed.
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Conclusion
To conclude, the Pennant Pattern is a commonly appearing continuation chart pattern that is used by traders in most financial markets to trade over a variety of different timeframes. It indicates that price will continue to follow the trend set by an initial breakout after a brief period of back and forth price consolidation, which takes the shape of a Symmetrical Triangle or a Pennant on the price chart.
Throughout this article, we have discussed different types of Pennant Patterns, how a Pennant Pattern can be identified and differentiated from other patterns that look similar to it. Few strategies to trade the Pennant Pattern, and the key advantages and limitations of trading this pattern were also covered within the scope of this article.
Overall, it is relatively simple, straightforward and objective to make trading decisions based on the Pennant Chart Pattern. That being said, as this pattern forms over a relatively brief period, it can be challenging at times to determine its presence while the pattern is still in formation. Therefore, although beginner and expert traders can all use this chart pattern alike, having some experience with this pattern makes identifying and trading it all the more simple.
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