One of the classic chart patterns that technical analysts look for is the pennant. Traders following technical signals typically implement new long or short positions following a breakout from the pennant pattern.
A pennant is formed from an initial large move in price that is termed as a “flagpole.” This is followed by a continuation period, but which eventually leads to a breakout in the same direction.
As with chart patterns in general, volume is key to defining a true pennant. In the bullish pennant case, the initial, vertical price movement should be accompanied by higher volumes.
The pennant phase itself, which looks like a small symmetrical triangle, must be seen to have weaker volumes. Just like the earlier flagpole stage, the breakout from the pennant phase should also be characterised by higher volumes.
Many traders seek to profit from a bullish pennant by implementing buy trades to capitalise on this breakout.
In the case of the bullish pennant pattern, traders will be looking for a breakout from the upper trendline of the symmetrical triangle in the pennant phase. A move above this upper level on higher volumes will prompt many traders to hit the buy button.
As with all trading strategies, it’s crucial to have a stop-loss order in place should the breakout prove to be a false dawn. Depending on your strategy, it may be appropriate to set the stop loss at the lowest previous price point of the pennant phase.
As an example, suppose you have perceived a bullish pennant pattern for sterling against the dollar. Having observed the pattern, you could place a buy order just above the pennant´s upper trendline. Imagine sterling rose from $1.36 to $1.40 in a sudden rally, but then consolidated around the $1.38 level.
A breakout then occurs at $1.39, with increased volumes confirming its veracity. The trader may choose to go long at $1.392, with a price target of $1.43. As in this example, the price target for the trade is often derived by transposing the earlier flagpole’s height to the level from which the price breakouts from the pennant triangle.
As well as the bullish pennant pattern, there is also the bearish case. The bearish pennant is formed by an upside-down flagpole followed by a symmetrical triangle continuation phase.
Again, the sharp, vertical move down must be accompanied by higher volumes, while we should observe weaker volumes in the pennant triangle itself. This time, traders will be looking for a breakout on the downside, past the level of previous price support.
This means we would typically be hitting the sell button once the price moves past the triangle’s lower trendline. However, this definitive move lower needs to be evidenced by higher volumes to ensure that it is a true breakout to the downside.
As the term suggests, a breakout refers to the case where an asset price moves through a point where there has been a certain level of resistance or support.
Resistance occurs when there is notable selling of the asset at a given level, so the price has previously been unable to move through this point. Higher trading volumes should confirm that there are indeed serious, possibly institutional buyers behind the sudden price increase.
While the breakout pattern is a technical signal then, there will often be a fundamental reason behind the price move. For instance, suppose a small biotechnology stock has just reported positive clinical results for a cancer drug.
In the forex market, a recent example is sterling, which has just been able to push through the $1.40 barrier against the US dollar as the market has priced in the greater probability of a transitional Brexit deal being reached.
As well as to the upside, breakouts also occur on the downside, when an asset price moves down through a level of previous support. The price will have tested this lower price level but been unable to progress due to strong buying at that point.
As with the upward price breakout scenario, we should want to see higher trading volumes to give us the conviction that this is a true breakout. Higher volumes mean there are likely to be serious sellers at work and the move lower is more likely to be sustained.