What Is a Pennant Chart Pattern in Technical Analysis? (2024)

What Is a Pennant?

In technical analysis, a pennant is a type of continuation pattern. It's formed when there is a large movement in a security, known asthe flagpole. Then, the flagpole is followed by a consolidation period with converging trend lines—the pennant—followed by a breakout movement in the same direction as the initial large movement, which represents the second half of the flagpole.

Understanding Pennants

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 look to enter new long or short positions following a breakout from the pennant chart 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 for pennants is often established by applying the initial flagpole's height to the point at which the price breaks out from the pennant. For instance, ifa 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 of Pennant Chart Pattern

Pennant trading comes with several downsides that trades should be aware of. One common mistake is premature entries into the market. 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 broader market context. Traders may focus only on the pennant pattern without considering external factors that could impact the trade. For example, think about 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 problme 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.

Failed Pennant Formations

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.

For example, low volume during the pennant formation can be a red flag. 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.

Psychology of Pennant Formations

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 reflective 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 thorough their positions. This period of consolidation represents a temporary equilibrium, where buyers and sellers are in a state of 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.

Example of a Pennant

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 trend line 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.

Flags vs. Pennants

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

Pennants are characterized by 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 creating a rectangular shape. If you're not sure which is which, take a look at the slopes of each.

The Bottom Line

Pennant formations are short-term continuation patterns identified on price charts. They're characterized by a small symmetrical triangle created by converging trendlines. Traders often use pennant formations to anticipate breakout points, with the height of the initial strong move providing an estimate for potential price targets.