The Pennant pattern is a popular continuation chart pattern in technical analysis that signals a brief consolidation period before the price resumes its prior trend. It forms when the price consolidates within converging trendlines, creating a small symmetrical triangle. The pattern is called a “pennant” because of its flag-like appearance, where the price forms a sharp, narrow consolidation (the pennant) after a strong price movement (the flagpole). Once the price breaks out of the pennant, it typically continues in the direction of the previous trend.

In this article, we will explain how the Pennant pattern works, how to identify it, and how traders can use it to make informed trading decisions.

What is a Pennant Pattern?

A Pennant pattern forms after a sharp price movement, where the price consolidates within a small, symmetrical triangle. This consolidation occurs as the market temporarily pauses, with lower highs and higher lows creating converging trendlines. The pattern indicates a period of indecision in the market, where both buyers and sellers are fighting for control. Once the price breaks out of the pennant’s trendlines, it typically continues in the direction of the prior trend.

Key Components of a Pennant Pattern:

1. Flagpole: The sharp price movement before the formation of the pennant. The flagpole represents the strong trend that precedes the consolidation.
2. Consolidation: The narrowing price range that forms the pennant. It is characterized by converging trendlines, with lower highs and higher lows.
3. Breakout: The breakout occurs when the price moves decisively outside of the pennant’s trendlines. A breakout to the upside indicates a continuation of the uptrend, while a breakout to the downside signals a continuation of the downtrend.

Types of Pennants:

• Bullish Pennant: This type of pennant forms during an uptrend and signals that the price is likely to continue moving higher after the breakout. The flagpole is an upward price movement, and the pennant is a consolidation before the upward trend resumes.
• Bearish Pennant: This type of pennant forms during a downtrend and signals that the price is likely to continue moving lower after the breakout. The flagpole is a downward price movement, and the pennant is a consolidation before the downward trend resumes.

How to Identify a Pennant Pattern

Identifying the Pennant pattern involves recognizing the sharp price movement followed by a consolidation phase, and then looking for a breakout. Here’s how to spot and interpret a Pennant pattern:

1. Look for a Strong Trend (Flagpole)

A Pennant pattern forms after a sharp price movement, known as the flagpole. The flagpole is a strong price move in either direction, usually accompanied by high volume. This strong trend sets the stage for the consolidation phase that follows.

• Bullish Flagpole: An upward price movement forms the flagpole in a bullish Pennant pattern.
• Bearish Flagpole: A downward price movement forms the flagpole in a bearish Pennant pattern.

2. Consolidation (The Pennant)

Once the flagpole is formed, the price enters a consolidation phase, where the market pauses and the price action narrows. This creates converging trendlines, with lower highs and higher lows, forming the pennant shape. The price consolidates in a small triangular or wedge-like pattern.

• Symmetrical Triangle: The price moves between two converging trendlines, with the highs getting lower and the lows getting higher. This creates a symmetrical triangle shape, which is the defining feature of a Pennant pattern.

3. Breakout

The final step in the Pennant pattern is the breakout. The price will break out of the consolidation range, typically with an increase in volume, signaling that the previous trend is likely to continue.

• Bullish Breakout: A breakout to the upside indicates a continuation of the uptrend.
• Bearish Breakout: A breakout to the downside indicates a continuation of the downtrend.

4. Volume Confirmation

Volume plays an important role in confirming the breakout. During the consolidation phase, volume typically decreases, and when the price breaks out of the pennant, there is often an increase in volume. A breakout with high volume supports the validity of the pattern and increases the likelihood that the price will continue in the breakout direction.

How to Trade the Pennant Pattern

The Pennant pattern is a continuation pattern, meaning it signals that the price will likely continue in the direction of the prior trend once the breakout occurs. Here’s how to trade using the Pennant pattern:

1. Entry Point

• Bullish Breakout: Enter a long (buy) position when the price breaks above the upper trendline of the pennant. The breakout should be accompanied by an increase in volume to confirm the breakout.
• Bearish Breakout: Enter a short (sell) position when the price breaks below the lower trendline of the pennant. Again, look for an increase in volume to confirm the breakout.

2. Stop-Loss Orders

To manage risk, place your stop-loss order just below the pennant’s lower trendline for a long position or just above the upper trendline for a short position. This helps protect your trade in case the breakout fails and the price moves against you.

3. Target Price (Take Profit)

To set your target price, measure the length of the flagpole (the strong price movement before the pennant formation). This distance represents the expected price move after the breakout. Add this distance to the breakout point for a bullish breakout or subtract it from the breakout point for a bearish breakout.

• Bullish Target Calculation: Add the length of the flagpole to the breakout point to set your target price.
• Bearish Target Calculation: Subtract the length of the flagpole from the breakout point to set your target price.

4. Confirm the Breakout with Other Indicators

To improve the reliability of the breakout signal, use other technical indicators to confirm the pattern. For example:

• RSI: The Relative Strength Index (RSI) can confirm whether the market is overbought or oversold, supporting the breakout direction.
• MACD: The Moving Average Convergence Divergence (MACD) can help confirm bullish or bearish momentum when the price breaks out of the pennant.
• Volume: Ensure that the breakout is accompanied by a significant increase in volume, as this validates the breakout.

5. Monitor for Continuation

After the breakout, monitor the price action for signs of continuation. If the price is moving in the expected direction, hold your position until it approaches your target price. If the price starts to reverse or shows signs of indecision, consider taking profits early or tightening your stop-loss.

Advantages of the Pennant Pattern

• Clear Breakout Points: The Pennant pattern provides clear breakout points, making it easier to set entry and exit levels for trades.
• Trend continuation: The pattern is a continuation pattern, which means that once the price breaks out, it is likely to continue in the direction of the prior trend.
• Reliable in Strong Trends: The Pennant pattern works best in strong trends, making it ideal for trend-following traders.

Limitations of the Pennant Pattern

• False Breakouts: Like all chart patterns, the Pennant pattern is not foolproof. False breakouts can occur, especially if the price fails to break out with sufficient volume.
• Requires Confirmation: To increase the accuracy of the trade, it’s important to confirm the breakout with other technical indicators, such as volume or RSI.
• Short Duration: The Pennant pattern typically forms over a short period, meaning that traders need to act quickly when the breakout occurs.

Practical and Actionable Advice

• Use Volume for Confirmation: Always ensure that the breakout is accompanied by an increase in volume. This confirms that the breakout is genuine and that the price is likely to continue in the breakout direction.
• Combine with Trend Indicators: Use trend-following indicators such as moving averages or the MACD to confirm the breakout and direction of the trend.
• Patience and Timing: Wait for the breakout to occur before entering the trade. Premature entries may result in false breakouts, so patience is essential.
• Risk Management: Always use stop-loss orders to manage risk, especially in case of false breakouts or unexpected price reversals.

FAQs

What does the Pennant pattern indicate?

The Pennant pattern indicates a continuation of the prior trend after a brief consolidation period. It signals that the price is likely to resume its previous direction once the breakout occurs.

How can I identify a Pennant pattern?

A Pennant pattern can be identified by the converging trendlines that form a small symmetrical triangle. The pattern follows a sharp price movement (flagpole) and consolidates before the breakout.

How reliable is the Pennant pattern?

The Pennant pattern is considered reliable, especially when it forms after a strong price movement and is confirmed with volume. However, like all chart patterns, it can produce false breakouts.

What is the best time to enter a trade with the Pennant pattern?

The best time to enter a trade is after the price breaks out of the pennant’s trendlines. Ensure that the breakout is accompanied by an increase in volume for confirmation.

Can I use the Pennant pattern for short-term trading?

Yes, the Pennant pattern is ideal for short-term trading as it often forms during periods of consolidation, followed by a breakout that resumes the previous trend.

Conclusion

The Pennant pattern is a valuable tool for forex traders, signaling the continuation of a strong trend after a brief consolidation. By recognizing the pattern, waiting for the breakout, and confirming the signal with volume and other indicators, traders can set up profitable trades. The Pennant pattern is most effective in strong trends, making it a perfect fit for trend-following strategies.