How does a Pennant Pattern work?

The pennant pattern in technical analysis is a type of continuation pattern that indicates the current trend has paused but will continue. The pennant is formed by a large move upward or downward, which is called the “flagpole”, followed by a sideways consolidation period that is characterized by converging trend lines, and concluding with the breakout in the same direction as the initial large move. Pennants share a similarity in structure with flag patterns, but with a pennant the consolidation range tightens and there are converging trend lines. The consolidation period typically lasts anywhere from one to three weeks. Traders should also take note of the volumes during the formation. The initial move will occur on a large increase in volume. Once the pennant begins, volume will decrease to average or even below average levels, and the final breakout will also see a large spike in volume. This chart shows an example of the pennant: Note the strong move higher that creates the flagpole, followed by consolidation to form the pennant, and then the breakout from the consolidation, which is also a strong move that mirrors the initial move.

Trading the Pennant

It is possible to trade pennant formations profitably by entering new long or short positions at the conclusion of the consolidation period. For example, in the chart above once the trader notices the formation of the pennant a limit buy order could be placed just above the upper trendline of the pennant. A more conservative approach would be to place the limit buy order above the highest level reached during the initial move higher. In either case the trader should watch for increased volume during the subsequent breakout to confirm the pennant pattern and if the pattern is confirmed hold until the price target is reached. Pennant price targets are set by using the initial flagpole move and applying it to the point where the breakout occurs. In the chart above the initial move begins at 1.3390 and goes to 1.4000 for a move of 610 pips. The breakout from the pennant occurs around 1.3870 and the price target is the same distance as the initial move, or 610 pips. This gives a price target of 1.4480. The breakout actually goes 100 pips beyond that, but a trader who closes their position at 1.4480 would be a very happy trader. A stop loss should also be placed just below the lowest point in the pennant, in case the pattern breaks down indicating a potential reversal. Pennants are usually used together with confirming indicators. For example, a trader might watch the relative strength index (RSI) during the consolidation to see when oversold levels are reached, indicating the second leg higher is likely to begin. Or the pennant may form near a major support level, such as the 50 or 200-day moving average line, where price bounces off the support line.