I once attended a neighborhood flea market that was scattered over various lanes, alleyways, parks and other public spaces. I asked a neighbor - is there a map? How do we know which places the festival is wet up at. She pointed upwards. Look at those colourful pennants, she said gesturing at rows of rainbow-coloured triangle shaped flags suspended above the street. When you see the pennants, continue in that direction.
The pennant flags indicated the continuation of the flea market much in the way that pennant flag patterns indicate the continuation of a given stock price trend.
So how is a pennant pattern identified? A pennant pattern basically forms on a graph when a sustained price trajectory witnesses a sudden and temporary reversal … or more precisely, a period of consolidation….only to find it's way back to the original trajectory.
Traders who spot a pennant pattern could have the potential to earn if the prediction that they make - based on the pennant pattern - works put to be correct.
Pennant patterns may be bullish or bearish meaning that they could be a sign for an impending stock price rise or an impending stock price decline. It depends on whether the preceding stock price trend - that is the trajectory of the stock price before the period of consolidation - was an uptrend or a downtrend.
A pennant pattern that is preceded by an uptrend is seen by traders as a sign of a potential impending uptrend A pennant pattern that follows a downtrend is seen by traders as a sign of a potential impending downtrend.
This is because the pennant pattern is a continuation pattern. However, do note that it heralds the continuation of the preceding stock price direction, not the ongoing stock price. In fact if you judge a pennant pattern simply based on how it moves with regards to the ongoing trend (that it breaks) then you would have to refer to it as a reversal pattern. However most traders would consider a pennant pattern to be a continuation pattern, more specifically, they announce the potential continuation of the preceding trend.
A few factors need to fall into place for a stock price movement to be classified as a pennant pattern.
Factor Number 1: You need to be looking at a snapshot of one to three weeks worth of stock pricing candlesticks.
Factor number 2: There needs to be be a clear dominant stock price trajectory, followed by a temporary period of consolidation. The dominant trajectory line is referred to as the flag pole and the period of consolidation is referred to as the pennant.
Factor number 3: During the period of consolidation the stock price needs to break away from the direction it is following during the period of consolidation. In other words it breaks away to return to its original or preceding trajectory.
Factor number 4: The price highs and price lows during the consolidation period should form an upper line and lower line that move towards a convergence. They should form a symmetrical triangle. If the lines move parallel to each other, they are forming a flag pattern, which has similar considerations and implications.
Factor number 5: Volume needs to support the assumption that the market will respond positively to the breakaway price movement. In other words volume should be high during the preceding price trend and at the start of the consolidation period, should weaken during the consolidation period and should increase when the price breakout.
Factor number 6: Relative strength index should migrate to moderate or medium during the consolidation and surge through your roof to oversold levels
Factor number 7: Alternatively, consolidation could take place at a point the creates altogether new support levels.
Factor number 8: Some traders say that even after the breakout occurs, it is best to wait for the stock price to confirm the prediction by actually moving in the direction of the prediction, that is by returned to the original trajectory.
Pennant patterns give traders an idea of where the stock price is headed and also to help them position their entry price, target price and stop loss.
For example, upon noticing a bullish pennant pattern, a trader might choose to enter at a price just above the upper trendline.
The target price is arrived at by adding the initial flagpole's height to the price breakaway point. For example if the price rose from Rs 142 to Rs 160 during the initial trajectory, then fell to Rs 155 during the consolidation and the breakout price was Rs 158, then the trader might fix the target price at Rs 176.
The stop loss is placed at the lowest point of the pennant pattern.
Pennant patterns can be a fairly good technical indicator for predicting stock price movements. However they must always be used in conjunction with other tools of technical analysis. In this podcast we have suggested bolstering your pennant pattern pegged prediction with Relative Strength Index and Volume but feel free to reconfirm using other indicators. The more confirmation, the better. Similarly, the higher the number of candlesticks that line up to form a pennant pattern formation on a stock price graph, the better.
No matter how certain you are of the outcome of your prediction, never lose sight of the fact that there are no guarantees on the stock market. Consider your risk appetite and trade accordingly.