Pennant pattern is one of the most popular price patterns among technical traders and investors. If you spot them right, bullish pennant and bearish pennant could give you a strategic edge over other traders and investors in the market.
Technical traders love price patterns because they analyze decades of past price data from a variety of markets, offering insightful information about supply and demand dynamics and market psychology, which may help them find possible buying or selling opportunities.
In this article we will talk about another top price pattern, the pennant pattern. Although it might sound more sophisticated, knowing its characteristics can offer important insights about market psychology. Let’s dive into the details of the pennant pattern, including what it is, what does it looks like, how to read it, and what is the market psychology behind it.
How to Trade the Pennant Pattern – Quick Guide
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What is a Pennant Pattern
Pennant pattern is one of the most common continuation chart patterns that occurs when a security price encounters a significant surge or decline, which is followed by a brief consolidation before resuming. The pattern resembles a small symmetrical triangle, named pennant, and can be formed of several candlesticks.
A defining element of the pennant pattern is the movement that precedes the stage of price consolidation in a narrower triangle, known as the flagpole. The instrument's trading volume is declining during this stage. A decreasing volume suggests that buyers and sellers are temporarily in equilibrium. To identify possible trading opportunities, seasoned traders are usually waiting for a breakout in the direction of the preceding trend after the pennant pattern is complete.
Pennant patterns are typically categorized as bearish or bullish based on the direction of the prevailing trend. Here is a snapshot of their structure:
The setup and the implications of the pennant pattern are the same as those of a flag pattern. The only difference is that the pennant pattern's consolidation phase is marked by converging trend lines as opposed to parallel trend lines. Traders use these patterns that emerge in various financial markets, such as forex market, cryptocurrency and commodities markets, as well as stock market, to make predictions about the future price action.
Key features of a Pennant Pattern
There are three key features that traders should consider within a valid pennant pattern:
The trend
The pennant pattern formation starts out with a strong existing trend. This initial movement, commonly referred to as the flagpole, establishes an obvious orientation. The rally must be strong enough to attract the attention of traders and investors, resulting in increasing buying or selling activity and a high trading volume.
The pennant
Following the surge or decline, there is a consolidation period, forming a tiny symmetrical triangle, known as a pennant. During the consolidation phase price makes lower highs and higher lows, indicating a market pause, when prices gather enough momentum to resume the trend. During this stage, price action narrows and volume often falls.
The breakout
The breakout is the last part and perhaps the most important for a trader. The price confirms the continuation pattern, making the breakout in the same direction as the prevailing trend. The increased volume following the breakout should support the trend and provide traders a solid signal to enter the market.
A pennant pattern depicts the diverging views of the market players, the struggle between bulls and bears. The underling psychology of the market is what shapes the pennant pattern itself.
Pennant patterns are psychologically characterized by the idea of market hesitation. Following a major price movement, either higher or lower, traders and investors usually pause and carefully assess their positions. Within this moment of consolidation, buyers and sellers experience uncertainty because of the temporary equilibrium.
What is a Bullish Pennant?
Bullish pennant is a price pattern that signals an imminent continuation of an extensive uptrend. It occurs during strong bullish trends and is formed by a flagpole, followed by a consolidation or a pause, when price is fluctuating between converging support and resistance line, and a breakout of the upper border.
A bullish pennant pattern can appear on a variety of timeframes. While traders with long-term strategies may identify those that emerge over weekly or monthly charts, scalping or day trading oriented traders will usually search for them on minutes or even seconds charts. When attempting to spot a pennant pattern, traders are usually checking several visual cues.
Here is how a bullish pennant looks like on a chart:
A bullish pennant pattern psychology is based on traders' behavior and market condition. Due to traders' desire to profit from the upward movement, there is a surge of purchasing pressure during the early rally. A transitory equilibrium between buyers and sellers is reflected in the price consolidation into a pennant, as neither the bulls or the bears have the necessary strength to determine a significant price movement.
The potential breakout may happen when buyers rebuild confidence, which could be influenced by positive news or favorable market circumstances and determine a new bull run.
What is a Bearish Pennant?
A bearish pennant is continuation patterns also, but it occurs within strong downtrends. It is basically the opposite of a bullish pennant, where the price pauses after a sharp decline, rather than consolidating after a surge. A bearish pennant pattern on the price chart can be spotted using the same methodology as the bullish pennant, but in the opposite direction.
When the price breaks through the pennant's lower trend line and trend resumes, we have a confirmed bearish pennant pattern. Like the bullish pennants, declining volume frequently indicates the formation of a bear pennant. Once the price makes the breakout, the volume should increase significantly.
Here is how a bearish pennant looks like on a chart:
A bearish pennant is characterized by a market sharp decline (creating the pole) due to pronounced negative sentiment. Bulls feel that there may be a reversal in the price, and the sellers who drove it down may subsequently retreat and take their profits, causing a price consolidation.
However, any consolidation is ending, and the lack of bullish sentiment favors the breakout pushing the prices down. Any sellers who have been holding back will jump in if the support line cedes, which will lead to new price lows.
It's crucial to differentiate pennant patterns from other price patterns such as rising and falling wedges, triangles, as well as flag patterns.
To do so, you may consider the following key points:
- In contrast to triangles, a pennant pattern begins with a price surge/decline.
- Unlike wedge patterns, where both support and resistance lines are slopping upwards/downwards, a pennant pattern consolidation is tighter and approximately symmetrical.
- Withing a pennant pattern, resistance and support lines are converging rather than being equidistant, as to the flags.
Bullish Pennant vs Bearish Pennant
Knowing the key differences between bullish and bearish pennants will allow traders to adapt their approach depending on different market circumstances. This ability could enhance their overall trading performance and give them the opportunity to capitalize on continuation patterns.
Bullish Pennant
Bearish Pennant
The trend Occurs after a price surge Occurs after a price decline The signal Signals a bull market continuation Signals a bear market continuation The breakout Price breaks above the resistance Price breaks below the support
How to Trade Pennant Patterns
After talking about pennant pattern's formation and what it is, let's see how you can trade it.
As soon as you spot a pennant pattern, you can trade it using derivatives such as CFDs. Because you do not own the underlying asset when you trade derivatives, you may go both long (buy), or short (sell). This allows you to speculate on price swings, which means you can trade both the bullish and the bearish pennant pattern.
Trading a pennant pattern may seem simple. However, it requires a systematic approach and a careful analysis. On your chart, you should search for a distinct pennant pattern within a strong directional movement. After that, you should watch for a breakout in the direction of the prevailing trend. If you are dealing with a rising pennant, you should expect for a breakout above the resistance line, which would suggest that the bull run may continue. In contrast, a bearish pennant might represent an opportunity for a short trade, if price breaks below the support line.
Here is what you should know before trading a pennant pattern:
Pennant Pattern Trading Step-by-Step
Bullish and bearish pennants are predictable patterns. However, trying to trade them without a clear plan could be a tough job even for seasoned traders. Here is a step-by-step plan for trading the pennant patterns.
1. Defining the entry point
Depending on your expertise, trading style and risk tolerance, establishing the entry point for a pennant pattern trade could imply three scenarios.
- Conservative: when price retested the broken level
- Moderate: a candlestick close above the pennant breakout
- Aggressive: right after the breakout
2. Setting the stop-loss
This is the step that will help you manage your risk and protect your trading account if the breakout is not sustained, or if the market reverses course.
- Conservative: beneath pennant's support (bullish pennant) or above pennant's resistance (bearish pennant)
- Moderate: below the breakout candle (bull pennant) or above it (bear pennant)
- Aggressive: below the pennant pattern’s low (rising pennant), or above the high (bearish pennant)
3. Establishing the profit target
In trading, maximizing potential profits is as important as limiting losses. Different traders may have different measuring techniques to estimate a pennant pattern price target after the breakout.
- Conservative: 1:2 risk-reward ratio
- Moderate: the thickness of the pennant at its base
- Aggressive: the flagpole's height added to the breakout point
Traders should always carry out in-depth research, adjust their strategy in the light of the current condition of the market, and consider combining pennant patterns with trading indicators and fundamental analysis.
And, above all, remember that markets don't always move as we expect them to, thus traders should always practice conservative risk and money management.
How to Get Started with CAPEX.com
- Open a trading account: To get started with pennant pattern trading, open an account with us. Choose between a live account to trade CFDs straight away, or practice first on our demo account with virtual funds.
- Choose your financial instrument: Pennants can be spotted in most financial markets, especially those that are more dynamic, such as forex, cryptocurrencies, and stocks.
- Explore our trading platform: We offer multiple chart types, as well as a range of order execution tools for fast trading, which in turn helps you to manage risk.
Conclusion
Traders can use pennant patterns as useful tools to spot price consolidation periods and make predictions about price future action. Still, it's critical to stay mindful of possible false breakouts and reversals caused by shifting market dynamics or breaking news. In addition to that, it is crucial to identify the trend, to monitor the volume and wait for a breakout before entering a trade.
This is why it is recommended to take your time to learn about this pattern and practice before you integrate it in your trading strategy, as well as corelate it with additional analysis techniques and trading indicators.
Free resources
Before you start trading chart patterns, you should consider using the educational resources we offer like CAPEX Academy or a demo trading account. CAPEX Academy has lots of free trading courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader or make more-informed investment decisions.
Our demo account is a suitable place for you to get an intimate understanding of how trading and investing work – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for investors who are looking to make a transition to leveraged securities.
Sources:
https://chartpatterns.com/
https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/technical-analysis
https://research.stlouisfed.org/wp/more/2011-001