Pennant Chart Pattern: A Guide to Continuation Signals in Technical Analysis

What Is a Pennant?

A pennant chart pattern is a technical analysis continuation signal comprised of a flagpole and a consolidation period with converging trend lines, commonly lasting from one to three weeks. The initial strong move is paired with varying volume levels, and traders monitor for a breakout in the direction of the original trend. Understanding pennants alongside other technical indicators can optimize trading strategies and target successful entry points.

How to Identify and Understand Pennant Chart Patterns

Pennants, which are similar to flags in terms of structure, have converging trend lines during their consolidation period and last from one to three weeks. The volume at each period of the pennant is also important. The initial move must be met with large volume, while the pennant should have weakening volume, followed by a large increase in volume during the breakout.

Here's an example of what a pennant looks like:

In the image above, the flagpole represents the previous trend higher, the period of consolidation forms a pennant pattern, and traders watch for a breakout from the upper trend line of the symmetrical triangle. 

Many traders enter new positions after a breakout from the pennant pattern. For example, a trader may see that a bullish pennant is forming and place a limit buy order just above the pennant's upper trendline. When the security breaks out, the trader may look for above-average volume to confirm that pattern and hold the position until it reaches its price target.

The price target is often set by adding the flagpole's height to the breakout point. For instance, if a stock rises from $5.00 to $10.00 in a sharp rally, consolidates to around $8.50, and then breaks out from the pennant at $9.00, a trader might look for a $14.00 price target on the position—or $5.00 plus $9.00. The stop-loss level is often set at the lowest point of the pennant pattern, since a breakdown from these levels would invalidate the pattern and could mark the beginning of a longer-term reversal.

Most traders use pennants in conjunction with other chart patterns or technical indicators that serve as confirmation. For example, traders may watch for relative strength index (RSI) levels to moderate during the consolidation phase and reach oversold levels, which opens the door for a potential move higher. In other cases, the consolidation may occur near trendline resistance levels, where a breakout could create a new support level.

Limitations and Risks of Trading Pennant Patterns

Pennant trading comes with several downsides that traders should be aware of. A common mistake is entering the market too early. Some traders may initiate positions too early, trying to anticipate the breakout before it actually occurs. This impatience can lead to entering trades during the consolidation phase which increasing the risk of false signals.

Another pitfall in pennant trading involves neglecting the broader market context. Traders might ignore external factors and focus. For example, think about how broader economic events may impact more than just one security. Equities may tip their hand and show where they may be headed, but events out of the company's control may oppose the expected price movement.

The last downside to consider is the problem of overlooking risk. Failing to set appropriate stop-loss orders or neglecting position sizing can expose traders to excessive or unnecessary risk. Traders should establish clear risk-reward ratios and diversify their portfolios to mitigate risks associated with individual trades.

Why Pennant Patterns Fail and How to Avoid Mistakes

There are several reasons why a pennant pattern might fail. One common reason is a lack of confirmation from other technical indicators. As mentioned in the last section, traders often make the mistake of solely relying on the pennant pattern without considering additional signals from indicators such as volume, momentum oscillators, or trend lines.

Low volume during the pennant formation can indicate potential problems. This is because this means weak market participation and a higher likelihood of the pattern failing to produce the anticipated price movement.

Another reason for failed pennant patterns is external market events or news that override the technical signals provided by the pattern. Unexpected announcements, geopolitical events, or economic data releases can quickly change market sentiment, rendering the pennant pattern obsolete. Also mentioned above, there may be broader market considerations that cause pennant formations to fail to form.

The Psychology Behind Pennant Chart Patterns

Traders may choose to trade pennant formations because pennants align with the trader's psychology. In either case, understanding the psychological factors behind pennant patterns can provide valuable insights for traders seeking to make informed decisions.

The formation of pennant patterns in price charts reflects the ebb and flow of investor sentiment and the tug-of-war between bulls and bears. Pennants are typically seen as a manifestation of a temporary pause or consolidation in the market, and the psychological dynamics during this phase contribute to the pattern's formation.

One key psychological factor driving pennant patterns is the concept of market indecision. After a significant price movement, whether up or down, traders and investors may take a moment to think through their positions. During consolidation, buyers and sellers reach a temporary balance, reflecting uncertainty.

By being attuned to the emotional dynamics driving pennant formations, traders can enhance their ability to navigate these patterns and capitalize on the subsequent price movements.

Real-Life Example of Trading With a Pennant Pattern

Let's take a look at a real-life example of a pennant:

In the above example, the stock creates a pennant when it breaks out, experiences a period of consolidation, and then breaks out higher. The upper trend line (resistance) of the pennant also corresponds to reaction highs. Traders could have watched for a breakout from these levels as a buying opportunity and profited from the subsequent breakout.

Comparing Flag and Pennant Chart Patterns

Pennants and flag patterns are often confused with each other as they look alike, but they have distinct characteristics that traders need to understand to make accurate technical analyses.

Pennants have converging trendlines that form a small symmetrical triangle. The converging lines indicate a temporary consolidation or pause in the market before a potential continuation of the existing trend. The price movement within a pennant usually has low volatility, and the breakout from the pattern is typically accompanied by a surge in trading volume.

On the other hand, flags exhibit a more rectangular shape. It may also sometimes resemble a small parallel channel. The parallel trendlines in a flag pattern indicate a brief consolidation, with the price moving in a channel against the prevailing trend. Like pennants, flags are typically seen as a continuation pattern, and the breakout direction is expected to align with the existing trend.

To most easily spot the difference between a pennant and a flag, take a look at the slope of the trendlines. Pennants have trendlines that converge and form a symmetrical triangle, while flags have parallel trendlines that create a rectangular shape. To tell the difference, notice the slopes of the trendlines.

The Bottom Line

Pennant chart patterns are continuation patterns formed by a period of consolidation followed by a breakout, often used by traders to predict future market movements. These formations generally occur over one to three weeks and involve converging trendlines that create a small symmetrical triangle. Key elements include lower volume during consolidation and a breakout with increased volume, which traders use to confirm the pattern. While they can assist in identifying potential breakout points and price targets, traders should combine pennants with other technical analysis tools to avoid premature entries and consider broader market factors to mitigate risks.