A pennant is a long narrow flag… nope, we are not talking about those flags you see in high school sports teams or ships! Here, we are referring to the chart pattern, which, of course, resembles a pennant.
Traders have created peculiar names like shooting stars, head and shoulders, and Doji stars for interesting formations they see in the markets. The pennant is no different. So, without further ado, let’s put a magnifying glass on this set-up and how to trade it.
What is the pennant chart pattern?
The pennant is a breakout pattern that appears in a variety of CFDs markets like FX, crypto, metals, stocks, and options. It looks just like a pennant with a flagpole that signals a continuation breakout. We have two types: the bullish and bearish pennant chart patterns.
The bullish version of the set-up is where we expect prices to rise, or move upwards while the bear pennant chart pattern is where we expect prices to drop, or fall.
In either case, this occurs regularly in ranges or consolidation and signals a break of structure either bullish or bearish.
The highs and lows begin converging into a vortex. Such a formation leaves the price no choice but to break out of the structure. This makes the pennant effective because the result is usually a fast, parabolic-like movement.
Identifying the pennant chart pattern
To identify a pennant chart pattern, you first need to understand the concept of support and resistance
In the world of forex trading, support and resistance are essential concepts used to determine potential price levels where the market may either reverse or continue its trend. They help traders to make informed decisions on when to enter or exit trades. Prices move on the concept of demand and supply, and the movement of price is dependent on the weighing of scales between supply and demand. This means when demand outweighs supply, the market is bullish and when the supply outweighs the demand, the market is bearish.
What is Support?
Support refers to a price level where buyers are expected to enter the market and stop further price declines. It is typically identified as a level where the price has previously bounced off multiple times. Traders look for bullish signals such as price action patterns or indicators when the price approaches a support level to confirm a potential price reversal.
What is Resistance?
Resistance, on the other hand, is a price level where sellers are expected to enter the market and stop further price increases. It is typically identified as a level where price has previously encountered difficulty breaking through. Traders look for bearish signals such as price action patterns or indicators when the price approaches a resistance level to confirm a potential price reversal.
To identify the Pennant chart patterns, traders must be able to quickly know where their support and resistance levels are in different market situations.
It’s important to note that support and resistance levels are not just found horizontally (as seen in the diagrams above) but also diagonally, whether ascending or descending in a trendy market scenario, and can be used to predict either a buy or sell scenario.
A resistance trend line sloping in a downward trend
It is also very common for traders to confuse the pennant formation with other chart formations like the symmetrical triangle and wedge.
- A pennant is neither a symmetrical triangle nor a wedge.
What is a symmetrical triangle?
A symmetrical triangle is quite similar to a pennant because it’s a continuation formation. It looks like two lines that are sloping towards each other, coming to a point at the end. It’s called “symmetrical” because both lines have the same slope. This pattern usually happens when the price of a currency pair is moving up and down, but not making any clear trend (also known as a ranging market) in either direction. It can show that traders aren’t sure what will happen next and are waiting for more information before making a decision.
As the two lines come closer and closer together, it’s a sign that a big change in the price might be coming soon. When the price breaks out of the triangle by moving through one of the lines, it can be a signal that a new trend is starting. For example, if the price breaks out of the triangle by moving up through the top line, it can mean that the currency pair is going to start moving up more consistently. If it breaks out by moving down through the bottom line, it can mean that the currency pair is going to start moving down more consistently.
Here’s an image of a symmetrical triangle below (for comparison purposes).
What is a wedge?
A wedge is a technical chart pattern that forms when the price of a currency pair moves between two converging trend lines, creating a triangle-like shape. There are two types of wedges: rising wedge and falling wedge.
A rising wedge is a bearish pattern that forms when the price moves between a flat or slightly upward-sloping top trend line and a steeper upward-sloping bottom trend line. This pattern indicates that the buying pressure is weakening and the bears may soon take control of the market.
A falling wedge is a bullish pattern that forms when the price moves between a flat or slightly downward-sloping top trend line and a steeper downward-sloping bottom trend line. This pattern indicates that the selling pressure is weakening and the bulls may soon take control of the market. Wedges are also a trend continuation pattern, meaning that the price is likely to continue moving in the direction of the existing trend once the wedge is broken. A breakout from a wedge pattern is considered significant and traders often look for a breakout confirmation before entering a trade.
Now that we’ve cleared up any confusion, let’s dive into the fun stuff and explore the key components of the pennant chart pattern!
The pennant formation consists of the following:
- Flagpole: This is the first leg of the movement before the consolidation.
- Breakout zone: This is where we expect the market to push out of the pennant forcefully.
- Pennant: This, of course, is the crux of the entire pattern. A pennant is triangular, consisting of two trend lines converging at about a 45° angle. These act as the support and resistance where the price bounces.
As a rule of thumb, the trend line should touch at least three swing highs/lows to be valid.
Having learned the basic process of how to identify this setup, let’s look at the simple entry and profit-taking rules.
The best way to confirm a breakout from a wedge is to wait for the price to close beyond the boundary of the pattern, and then monitor the price action to see if the momentum continues in the same direction. In addition, traders may use other technical indicators or chart patterns to confirm the wedge breakout signal. Wedges are an important tool for forex traders as they can provide valuable information about potential trend reversals or continuations, and can help traders make informed trading decisions.
Either way, it’s a conservative approach to enter once the breakout has occurred compared to another period.
Your stop loss should be at the most recent low of the support (for a bullish pennant) or the most recent high of the resistance (for a bearish pennant).
Finally, the profit target is generally the distance of the flagpole. Here is an image demonstrating all of these parameters in better detail.
Pennant pattern chart examples
Let’s go straight to real markets to see this setup in action. Our first example shows the bullish candlestick pennant chart pattern on GBP/JPY. Here, we see two nice impulses before the formation of the flagpole.
This, of course, led to the pennant. We have labeled where your entry and stop loss would have been below. Additionally, the market traveled the height or distance of the flagpole.
Now let’s look at the candlestick pennant chart pattern on the CAD/CHF pair. The set-up begins with a downward impulse (the flagpole) before the price contracts. After the formation, the market moved even further down.
Conclusion
The pennant chart pattern is a rare formation. But it can be pretty effective once it appears, particularly in higher time frames. As with other set-ups, you should always add more confirmation elements to your trading idea to increase the probability of success.
One thing to consider is that geometric set-ups like pennants generally need larger stops. Therefore, you may choose to enter at a different time than usual. Regardless, your reward must always be at least twice the risk.
Glossary
- Bullish, bulls:- is a trading sentiment where traders are expected to rise.
- Bearish, bears:- is a trading sentiment where prices are expected to fall.
- Ranging Market:- This pattern usually happens when the price of a currency pair is moving up and down, but not making any clear trend.
- Pair:- In forex trading, a pair is a combination of two different currencies that are traded against each other in the forex market. The first currency in the pair is known as the base currency, and the second currency is known as the quote currency.
- Trend: In forex trading, a trend refers to the general direction in which the price of a currency pair is moving over a certain period of time. A trend can be either up or down.
