Suppose that a stock that you’re watching suddenly moves sharply lower. After the significant move, the stock starts to trade sideways in a narrowing range. Should you buy the stock following the dip or is this just the start of a prolonged move lower? These kinds of questions are common for active traders.
In this article, we will look at a bearish continuation pattern, known as the bearish pennant, which can help you answer these questions and avoid buying into bearish markets.
What Is a Bearish Pennant?
Bearish pennants, or bear flags, are continuation patterns that occur following a strong downtrend. After a move lower, the price moves sideways in a narrowing price range that resembles a triangular flag – or pennant. The downtrend continues when the price breaks down from the pennant on above-average volume.
After a strong move lower, many short-term traders will lock in profits by buying back their short positions. These dynamics create the bearish pennant – a brief period of consolidation – but the market is still net sellers and the downtrend resumes after these short-term traders have sold out.
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The bearish pennant as several key components:
- Prior Downtrend: The bearish pennant should be immediately preceded by a sharp move lower on heavy volume, which is often the first leg of a long-term trend lower.
- Flagpole: The flagpole is a vertical line that connects the first resistance breakout to the low of the pennant.
- Pennant: The pennant is the symmetrical triangle that begins wide and converges over time until a breakdown occurs. The price action should be contained within the pennant, although there may not be specific reaction highs and lows.
Bearish pennants typically last one to four weeks. If they last any longer, traders often classify them as a symmetrical triangle.
The opposite of a bearish pennant is a bullish pennant. You can learn more about it here.
How to Trade Bearish Pennants
Bearish pennants are relatively straightforward to trade.
Sell, or short, signals are generated when the price breaks down from the bearish pennant on above-average volume. Often times, traders also look at other technical indicators and chart patterns to use as confirmation of the breakdown.
Stop-loss points, for traders entering short positions, are typically placed at the top of the bearish pennant. In addition to stop-loss points, short sellers may use a trailing stop-loss to lock in profits as the price moves lower.
Take-profit points are usually set by calculating the height of the flagpole (in price) and applying that number to the point at which the breakdown occurs to produce a lower price target.
Learn more about other trading strategies here.
Examples of Bearish Pennants
Let’s take a look at a bearish pennant in Unisys Corp. (NYSE: UIS), as example of these concepts in action.
In the chart above, the initial breakdown occurred on November 9 and lasted until November 13. The stock then experienced a period of consolidation that formed a bearish pennant.
The short seller’s entry point for the pennant would have been around $15.50 following the initial move lower. The stop-loss would be set just above those levels, while the take-profit point would be $12.50.
The stock broke down from the bearish pennant, as expected, and is nearing the take-profit point.
The ongoing downtrend is confirmed by the bearish moving average convergence-divergence (MACD) that accelerated its downtrend, although the relative strength index (RSI) is reaching oversold levels that could suggest some longer-term consolidation.
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The Bottom Line
Bearish pennants are a continuation pattern designed to differentiate between a reversal and a period of consolidation along the way down. Using the chart pattern, short sellers can intelligently enter trades with intelligent stop-loss and take-profit points, while long traders can exit positions before the price continues to move lower.
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