A pennant is a triangle-shaped chart pattern formed by consolidating price action following a directional market move or trend. Pennants are classified as continuation patterns, meaning their presence acts as a signal that the market is merely taking a pause, and the preceding trend has a good chance of extending its range in the near future.
In general, chart patterns have the most predictive value when they exhibit specific characteristics. For continuation patterns such as flags and pennants, the presence of the pattern itself acts as an indication of a potentially larger market move.
For a pennant to exist and act as a predictor of future price movement, the following market characteristics and elements of price action must be present:
- Directional Price Move: A definitive move in price, or relative trend, is needed to create the environment for pennant formation.
- Volume: Market participation is a key element of a trending market. Robust volume during the initial price move preceding pennant formation lends credence to the probability of trend extension. Mildly decreasing volume during pennant formation can be interpreted as a good sign that market participants are not exiting the market, but looking for an optimal entry point to continue the preceding trend.
- Duration: Pennants are considered to be one of the more rapidly forming chart patterns. If formation has taken too long in relation to the time frame being traded, then its validity comes into question.
Pennants have several inherent qualities that are present no matter the time frame or product being traded. The following components must be present for a pennant to exist:
- Flagpole: The flagpole represents the original trend. It is the distance from the beginning of the directional price move to its high or low point.
- Triangle: The triangle serves as the outline of the pennant and is constructed by drawing two converging trendlines; one connecting the high values of the consolidation range, and one connecting the lows. The two trendlines converge, forming a triangle.
- Slope: Slope is defined by the triangle's trendlines in relation to the flagpole. The triangle slopes against the trend illustrated by the flagpole, and is classified as either bullish or bearish depending on if the initial trend is up or down.
- Retracement: Retracement of a pennant is measured by taking the high or low point of the flagpole from the high or low point of the pennant itself. Often, tools such as fibonacci retracements are used in concert with pennant formations to determine the likelihood and size of a potential breakout.
Pennants are one of the most readily identified chart patterns among market participants, and studies have shown that continuation patterns are some of the most reliable chart patterns to trade. Various trading strategies are based on the recognition and presence of pennants, most of which aim to capitalise on a trending market.
However, pennant formation can be challenging to recognise in real-time, and larger-sized trends and consolidation ranges require substantial capital to trade properly. It is ultimately up to the trader whether or not to incorporate the use of pennants into a trading plan.
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