The stock that you’ve been watching suddenly experienced a sharp increase in price, but it started moving sideways following the breakout. How do you know if this is a brief period of consolidation or the start of a bearish reversal? These kinds of situations are very common for active traders.
In this article, we will look at a bullish continuation pattern, known as a bullish pennant, which can help answer these questions and help you identify profitable trades.
What Is a Bullish Pennant?
Bullish pennants are continuation patterns that occur during a strong uptrend. After a strong move higher, the price moves sideways in a pattern that resembles a triangular flag – or pennant. The uptrend continues when the price breaks out from the narrowing price pattern on above-average volume.
There is a psychological underpinning for the bullish pennant: Short-term traders are simply locking in some or all of their profits following a sharp move higher. Since the market still consists of net buyers, the security resumes its uptrend when these short-term traders have sold out of their positions.
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The bullish pennant has several key components:
- Prior Uptrend: The bullish pennant must be preceded by an uptrend, including a sharp move higher on heavy volume. Often times, this is the first leg of a longer-term trend higher with the pennant being a short pause on the way.
- Flagpole: The flagpole is a vertical line connecting the first resistance breakout to the high of the pennant.
- Pennant: The pennant is the symmetrical triangle that begins wide and converges over time until a breakout occurs. While there may not be specific reaction highs and lows, the price action should be contained within the pennant.
Bullish pennants are usually short-term patterns that last one to four weeks. If the duration lasts any longer, the chart pattern is often classified as a symmetrical triangle.
The bullish pennant is also known as a bull flag.
How to Trade Bullish Pennants
Bullish pennants are relatively easy to trade.
Buy signals are generated in the period following a candlestick that closes above the pennants upper trend line. When the breakout occurs, traders often look for heavy volume as confirmation. You can also look at other chart patterns or technical indicators for confirmation.
Stop-loss points are placed at the bottom of the pennant. In addition, some traders use a trailing stop-loss point that’s set equal to the pennant’s height.
Take-profit points are typically set by taking the height of the flagpole and applying it to the points at which the breakout occurred to produce an upper limit.
Learn more about other trading strategies here.
Examples of Bullish Pennants
Let’s take a look at a bullish pennant in Companhia Paranaense de Energy SA (NYSE: ELP) as an example.
In the chart above, the initial breakout occurred on September 17 and lasted until September 24. The stock then experienced a period of consolidation that formed a bullish pennant.
The entry point for the bullish pennant would have been at around $5.80 following the breakout from the pennant formation. The stop-loss is set at the bottom of the pennant at $5.10 and the take-profit is set at around $6.60.
The stock breaks out from pennant formation and reaches the take-profit level before trending sideways for a period of time.
The Bottom Line
Bullish pennants are a continuation pattern that can help you determine if a period of consolidation is a step along the way higher or a potential reversal lower. Using the chart pattern, you can intelligently enter trades complete with take-profit and stop-loss points to limit your risk.
The bullish pennant works best when combined with other forms of technical analysis, including both chart patterns and technical indicators. For example, the on-balance volume (OBV) can help determine the breakdown between buyers and sellers, while the relative strength index (RSI) can show trend strength.