The "Pennant" model in cryptocurrency trading: what is it and how to use it?

The "pennant" pattern is a consolidation figure that belongs to the continuation category of trends. This pattern forms over a shorter period compared to some other chart models and is usually observed in a more dynamic trading environment. Generally, a pennant is formed approximately in the middle of a developing trend. A breakout from the pennant serves as a signal to enter a position in the direction of the prevailing trend.

In this article, we will discuss how to recognize and apply the "pennant" pattern, how to trade based on this price formation, and we will also compare the pennant with other common chart patterns.

The Essence of the "Pennant" Pattern

The "pennant" figure is a continuation pattern that occurs in both rising and falling markets. It forms after a sharp price movement upward or downward when trading begins in a narrowing range, taking the shape of a small symmetrical triangle. This often happens in the middle of a price movement, signaling the start of the second half of the trend.

This is a fairly common pattern that can occur relatively often across various time frames, but is most typical for short-term timeframes. Pennants are similar to flag patterns, as both are preceded by a sharp rise that forms the "flagpole" before the consolidation phase. The boundaries of the pennant are defined by two trend lines: the upper line connecting the peaks is sloping down, while the lower line connecting the troughs is sloping up, so they intersect at the top of the triangle and are oriented horizontally.

Formation of the "pole"

To form a proper pennant, it must be preceded by a rapid and steep rally ( in a bull market ) or a sharp and steep price drop ( in a bear market ). Before the formation of the pennant, signs of aggressive buying ( should be observed in a bull pennant ) or selling ( in a bear pennant ) with high relative volume.

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A breakout usually occurs in the direction of the trend that preceded the formation of the pennant. The intensity of the previous trend is an important indicator of what to expect after the price breaks out of the formation. More aggressive trends preceding the formation of the pennant typically lead to more powerful subsequent moves.

A classic pennant typically forms over a couple of weeks, at most up to three weeks. If its formation is prolonged, it is likely to transform into a larger figure, such as a symmetrical triangle, or may lead to a pattern failure. A failure occurs when the price moves in the direction opposite to what was expected.

During the formation of a pennant, the trading volume should decrease. However, after the breakout, the volume should increase sharply, reflecting the enthusiasm of buyers or sellers and the potential for a sustained move upward or downward. A prolonged breakout period - this is why traders value this pattern so much.

Pennant vs Clinch

The pennant pattern is used as a continuation pattern, while the wedge can be both a continuation and a reversal pattern. Additionally, the wedge does not require the presence of a "handle". A preceding trend is sufficient.

Pennant vs Symmetrical Triangle

Both the pennant and the symmetrical triangle are continuation patterns and are similar in that they take the shape of a symmetrical triangle. The main difference is that the size of the pennant triangle is smaller than that of the symmetrical triangle. Additionally, a sharp steep trend must precede the pennant, whereas the symmetrical triangle can form within any trend.

Pennant vs Flag

Pennants and flags are considered continuation patterns and include a consolidation phase. The main difference lies in the shape of the consolidation after the "pole," as mentioned above.

Trading Strategies Based on the "Pennant" Pattern

Trading by the pennant is carried out on the breakout in the direction of the trend. However, there are several entry strategies that can be used to follow the trend.

1. Depending on whether it is a bullish or bearish pennant, enter the market at the initial breakout as soon as the boundary line is breached in the direction of the trend.

2. Enter on the breakout of the maximum or minimum of the pennant.

3. Enter the market on the initial pullback and subsequent continuation of the trend after the initial breakout.

The target level is determined by measuring the distance from the beginning of the "pole" to its top ( in a bull market ) or the base ( in a bear market ) until the formation of the pennant. The count should start from the moment when a sharp move breaks through the resistance or support level. The distance is measured either to the upper or lower boundary of the pennant depending on the trend direction.

The following example considers a classic entry on the breakout of a bearish pennant. The "flagpole" is measured from the breakout point at 6.48 (1) to the lower boundary of the pennant at 5.68, which gives a decline of 0.80. Then we subtract 0.80 from the breakout trigger level of 5.98 (2) to get a target level of 5.18 (3). The initial stop is then placed just above the resistance trendline to limit losses. For bullish pennants, the stop order should be placed below the support line.

How reliable is the "Pennant" pattern?

John Murphy, the author of the classic book on technical analysis "Technical Analysis of the Financial Markets," notes that the pennant pattern is one of the most reliable continuation patterns in technical analysis. However, Thomas N. Bulkowski's research in his book "Encyclopedia of Chart Patterns" showed that it is less reliable than some other patterns.

Bulkovski analyzed the effectiveness of more than 1600 pennant patterns identified by certain parameters for consistency. He found that the failure rate of breakouts for both upward and downward movements was 54% for each direction, with the average movement after the trigger was activated being around 6.5% (initial movement). The probability of success was 35% for upward movements and 32% for downward movements. Naturally, the above analysis confirms the importance of active risk management for success in trading, as patterns often fail.

It is worth noting that the results for the pennant may be somewhat understated, as Bulkowski points out that the pennant tests only took into account short-term price fluctuations and not the movement from a breakout to a potential maximum or minimum, as he did for other model tests. It is assumed that the results may improve if larger movements are taken into consideration.

Traders often use pennants in conjunction with other technical analysis methods to improve their decision-making process and increase their chances of success.

Bullish Pennant

A bullish pennant forms within an uptrend and begins with a sharp and steep rise, called the "pole." This is followed by a short period of consolidation that takes the shape of a pennant or a small symmetrical triangle. A bullish pennant is formed when the price is in a state of rest before continuing to rise to higher levels.

Bear Pennant

A bearish pennant is observed during a downtrend and starts with a sharp, steep decline forming the "flagpole." This is followed by a short period of consolidation forming the pennant. A bearish pennant is formed when the price is in a state of rest before it resumes its decline. Once the price breaks below the lower boundary, a bearish signal is triggered to open a short position.

Bullish Pennant vs Bearish Pennant

Despite the differences, the same approach can be applied to both bullish and bearish pennants in trading. The only difference is that you open a long position with a bullish pennant and a short position with a bearish pennant.

Conclusion

The pennant pattern in technical analysis is considered a continuation figure, as a breakout is expected to occur in the direction of the prevailing trend. This is one of the patterns with shorter time frames, as it completes within three weeks or less. This means that the breakout ( or the failure of the pattern ) must occur before the three weeks expire. The key to the success of the pennant is the quality of the preceding trend. A sharp and steep movement is expected before consolidation occurs, as the aggressive trading observed before the formation of the pennant is likely to continue after the breakout.