Technical Analysis – Pennants

A pennant is one of the most beautiful and powerful continuation patterns that exist in the technical analysis field. It is so powerful that if traders are on the wrong side of the market, they will rarely get the chance to get out. This happens because a pennant leaves little room for any kind of retracement. Before going into more detail about what a pennant is and how to trade it, let’s look at some generalities for this pattern:

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How to Treat a Pennant

There’s only one way to treat a pennant: to look for buying opportunities. As mentioned earlier, the retracement levels are so small that it is difficult to wait for a dip to go long. The simplest and most effective way is therefore to simply enter during the pennant’s formation, or to place a pending buy stop order at the highest point of the pennant. By doing this, it is impossible to miss the strong move that follows.

Wait for the Break.

The first thing to do is to simply wait for the break. Unlike bullish flags, which may take forever to consolidate, the pennant has a short consolidation. Whereas in the case of a bullish flag the two trendlines that define the pattern are parallel, a pennant has the two trendlines pointing to an intersection point. It means that a triangle is forming, and the angle of the two trendlines is aggressive. The chart below shows a pennant formation on the USD/JPY pair on the 4-hour timeframe, and the two methods described above worked like a charm as the right entries. This timeframe allows for the pattern to be identified, as the consolidation or the triangular area that defines the pennant took around 16 candles.
pennant - 1
Multiply this by the 4 trading hours that correspond to each candle, and the result is almost 3 full trading days. In other words, if one is actively trading the USD/JPY pair daily and pays attention to price action, it is virtually impossible to miss this consolidation. It is as if the price is screaming to break higher, so small and shallow are the retracements. Either entering on the long side during the pennant formation, or placing a pending buy stop order at the highest point, will do the trick for a profitable trade. Keep in mind that pennants are triangular formations that appear at the end of complex corrections, or in the middle of them. These complex corrections, in strong trends, form at the start of the overall move. Look at the chart below, as it shows the move that followed the pennant breaking higher. Not only did the pennant build energy to break, but it was followed by a super-strong bullish trend.
pennant - 2
All of this happened without the lows in the pennant formation being broken. If a picture is worth a thousand words, then this one is surely telling us everything we need to know about pennants and the power they have to show strong bullish trends that are about to form.

Avoiding Fake Moves

Not all triangles are pennants, that is for sure. So how do we know when a pennant is forming, and what should we do to correctly position for it? Here are a few tips and tricks to avoid being trapped in a pattern that looks like a pennant, but it is not confirmed by future price action:

This simple rule is enough to invalidate a fake pennant formation, and to keep traders on the right side of the market. For a long trade that is entered immediately after the pennant breaks higher, the apex line represents the stop loss for that trade. As for the take profit, there is really not one that comes to mind. The USD/JPY chart illustrates perfectly why setting a take profit after a pennant formation is not a good idea. The trend that follows is an aggressive one, and any take profit will result in the cost of opportunity being to miss the trend, and we want to avoid this at all costs. What can be done is to set a trailing stop order if the trading platform allows that. The value for the trailed stop should be set according to the timeframe the pennant appears on. The longer the timeframe, the higher the trailing stop value should be. In this way, riding a trend is possible with this beautiful continuation pattern.

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