Trading with the pennant pattern
When it comes to technical analysis, there are a number of different approaches. Some traders prefer to use the technical analysis based on technical indicators, while some others prefer to use custom price charts.
One of the most popular ways to trade the markets is by means of price action. Price action is nothing but observing the patterns that price forms in the chart.
The price charts tend to exhibit a repetitive feature of creating similar patterns. These patterns are created not by magic but by the traders who push prices around.
Depending on the strength of the bulls or the bears, price tends to evolve into certain observable patterns.
There are many different types of chart patterns that one can observe. Among these, the pennant pattern is one of the many.
The pennant pattern comes under the category of continuation pattern. A continuation pattern is defined as where price tends to continue its trend. The continuation patterns are a great way to trade in the direction of the trend.
Besides the continuation patterns, you will also find other chart patterns such as reversal patterns. However, the continuation patterns tend to be the strongest and are commonly occurring.
In this article, we take a look at what is a pennant pattern and how it is formed. We will later look at the difference between the pennant pattern and its close cousin, the flat pattern which is also a continuation pattern.
We will later define the rules on how you can spot the pennant pattern and how you can trade the pennant pattern based on a set of rules that have worked over a period of time.
How is a pennant pattern formed?
A pennant pattern, as you have seen earlier is a continuation pattern. When this pattern emerges, you can expect price to resume the previous trend. The pennant is formed as prices temporarily consolidate.
Traders might already know that the trend is your friend. In this context, the pennant patterns are the best chart patterns to trade. You can also club the pennant pattern alongside other technical indicators to trade the high probability pennant pattern chart set ups.
A pennant pattern is visually distinguishable based on strong price action. This price action is often sharp and rapid and moves in the direction of the trend. Following this sharp movement, prices tend to post a modest consolidation.
This consolidation takes the shape of a pennant pattern.
Once the pennant pattern is formed, price tends to breakout from this consolidation. In most cases, this breakout always occurs in the direction of the previous trend.
The first chart below shows a basic illustration of a pennant pattern.
The figure 1 depicts the two types of pennant patterns that are formed. The first is the bullish pennant pattern. This pattern is formed during an uptrend. The next pattern to the right is the bearish pennant pattern which is formed during a downtrend.
From the above picture, you can see that the patterns formed are easy to distinguish. The pennant is formed over a period of consolidation where price makes lower highs and lows consolidating into a type of triangle pattern.
When price breaks out from this pennant, it resumes the direction of the previous trend. Therefore, a breakout from the bullish pennant pattern signals that price will move to the upside and continue the upside.
Similarly, a breakout from a bearish pennant pattern will signal a bearish decline and price will resume the downtrend which was previously established.
The strong price action you see prior to the formation os the pennant pattern is known as the flag staff or the pennant staff.
How to trade the pennant pattern?
Now that we know how to identify the bullish and the bearish pennant pattern, let’s take a look at how to trade these patterns.
The pennant patterns are also known as measured move patterns. The reason why this name is given is because the target price following the formation of the pennant pattern is measured based on the length of the previous leg.
To trade the pennant pattern, you simply measure the distance of the staff from the low to the high and project this distance in the direction of the breakout. Examples of other measured move patterns include the head and shoulders pattern, the ascending and descending triangle patterns to name a few.
In many cases, price tends to move in a similar or even more distance that was measured and projected.
The next chart shows how the trades can be set up.
Figure 2 shows how the pennant pattern can be traded. As mentioned earlier, the flag staff is measured from the high to the low. This distance is then projected to the breakout of the pennant pattern in the same direction.
The entry is taken at the breakout level while the stops are placed at the most recent pivot low or high prior to the breakout.
In terms of risk and reward, the pennant pattern offers at least 1:2 risk reward set up making it quite popular among price action traders.
The move in the pennant pattern is quite often strong and the trade can be closed out quite quickly. However, it is important to note that not all pennant patterns always lead to a profit. There are instances when a pennant pattern can fail leading to a stronger than expected correction in prices.
Let’s take a look at some real time examples. In the next section we outline the bullish and bearish pennant patterns from some price charts.
The above chart gives an example of a bullish pennant pattern. Here, you can see that following a strong rally in price, we have a brief period of consolidation. This consolidation turns into a pennant pattern or a triangle pattern.
Following this, the breakout from the pennant pattern results in price pushing higher. The target is set to the same distance which is measured from the initial staff or the initial rally before forming the bullish pennant pattern.
The resulting breakout leads to price reaching the projected target which is nothing but the same distance from the initial point projected from the break out level.
The next example shows a bearish pennant pattern.
The rules as the same as you can see in figure 4. Following the breakout from the bearish pennant pattern, price action posts a strong decline. Eventually, the breakout from the bearish pennant pattern leads to price reaching the projected target.
The above two examples show how the pennant patterns are formed on the price chart. Traders should bear in mind that in most cases, the pennant pattern is not as near text book pattern as it seems.
Besides the pennant pattern, there is also the flag pattern which looks similar. In the next section we take a look at the differences between the flag and the pennant pattern.
Difference between the flag and pennant pattern
The flag and the pennant pattern are almost similar in terms of signifying the price action. Both are continuation patterns that occur within a trend. Sometimes, traders tend to confuse the flag pattern with the pennant pattern due to its similarity.
Overall, whether you are looking at the flag or the pennant pattern, both are consolidation patterns. These patterns occur during a temporary pause to the trend when consolidation occurs. As such, there are no major differences between the two.
Both the flag and the pennant patterns follow the same rules of price action trading. The only difference one see’s is the shape of the consolidation.
A flag pattern is formed when prices form within a channel and thus create the image of a flag. A pennant pattern on the other hand looks likes a small triangle. This is the only difference between the flag and the pennant pattern.
The rules of trading remain the same where in both the flag and the pennant pattern are traded based on the length of the flag staff which is then projected upwards or downwards from the breakout of the flag or the pennant pattern.
Both these patterns occur across different timeframes and can occur in different markets and are visible on the price charts. Therefore, regardless of whether you see a flag pattern or a pennant pattern, the trading logic and rules remain the same.
There is also no proven thesis that can put one pattern above the other. Therefore, essentially both the flag and the pennant patterns are basically the same.
The reason why the flag and the pennant pattern differ, is basically on how the consolidation takes place. Typically, when price moves smoothly, it tends to create the flag pattern, while peaks and lows in price action can create the pennant pattern.
Pros and cons of trading the pennant patterns
As with any technical trading strategy, there are both pros and cons with the pennant patterns that are formed. In this section we outline both the advantages and the disadvantages of trading with the pennant patterns so that the readers are well informed.
The advantages of trading with the pennant patterns are:
- The pennant patterns are one of the commonly occurring patterns when it comes to price action trading
- The pennant patterns are continuation patterns, therefore it is ideal to use these patterns to trade with the trend
- The pennant patterns can be combined with any technical trading strategy and used to validate the breakouts
- The risk reward is usually two times the reward and thus allows for traders to only focus on the pennant patterns for trading
The disadvantages of trading with the pennant patterns are:
- Because price action constantly evolves, traders need to be very experienced in trading with the pennant patterns
- Pennant patterns are not always successful and can lead to losses. Therefore, traders need to be aware of the risks. This is not a pattern that will make you rich.
- Pennant patterns, although being a continuation pattern can also, in some rare cases signal a reversal. These reversals can lead to quick price action moving in the opposite direction. Therefore, careful trade or risk management is required when using the pennant patterns.
- Most of the pennant patterns can be easily identified in hindsight but this is not the case when price action continuously unfolds.
Pennant pattern – Conclusion
In conclusion, the pennant pattern is one of the most commonly occurring price action patterns. These patterns can be found across any time frame and the rules of trading remain the same. Regardless of the markets that the pennant pattern is formed in, the logic remains the same.
Traders who use the technical price pattern based trading can make use of the pennant patterns to trade the markets successfully. While initially such chart patterns might be a bit difficult to spot, with enough practice traders can train their eyes to spot these patterns as they form in real time.
It should be mentioned once again that the pennant patterns are not 100% accurate. This means that there are times when the pennant pattern fails. However, given the risk to reward ratio that comes with the pennant pattern, the losses are minimal compared to the targets that can be achieved.
The most ideal pennant patterns are those that are formed near the support and resistance levels.
In this case, watch for the bullish pennant pattern to form near the resistance level. A breakout from the resistance level following the bullish pennant pattern can trigger strong gains and the probability of such trades are also much higher.
Likewise, a bearish pennant pattern that forms near support which is broken can also trigger quick rewards which a high amount of probability.
One the best things about trading with the pennant patterns is that they can also be combined with other technical trading strategies. For example, using technical indicators such as an oscillator or moving averages can be used to confirm the downside or the upside following the breakout from the pennant pattern.