Trading strategy: Pennant Pattern

Description

The pennant is a pattern. A pattern is recurring combination of candles (or bars). Individual candles are of limited value to traders. Patterns are much more interesting. The pennant pattern was originally developed for the forex market to capture break-outs which characterize this market. It can, however, be applied to indices, commodities or individual stocks.


  
Suitable for : Market indices (FTSE, DAX, AEX…)
: Forex (EUR/USD, GBP/USD ...)
: Commodities (oil, gold…)
: Shares
Instruments : Futures, CFDs and Forex
Trading type : Day trading
Trading tempo : 2-3 Signals per week
Using NanoTrader Full : Manual or semi-automated

 

The strategy in detail

The pattern consists of a "flagpole" (a) followed by a "pennant" (b). The flagpole, which must consist of at least three candles (or bars), corresponds to a sharp advance or decline in the market price of. This sharp advance or decline is followed by a consolidation. Due to decreasing volatility this consolidation takes the shape of a pennant. In a pennant pattern all the candles that come after the last flagpole candle must be inside candles i.e. candles which are within the extremes of the previous candle.


In most cases the pennant does not have the same clear pennant shape as in the illustration above.

 

This example shows a bullish pennant pattern (green background). The flagpole is clear but the pennant consists of is just one inside candle.


The Pennant pattern strategy is used for day trading on a 10-minute chart. Signals are, however, rare. Active investors who want to use this pattern should work with multiple indices. If they do not want to monitor each instrument themselves they can simply work with a LiveTables.

When to open a position?

A buy signal occurs when the market price moves above the high of the third candle in the flagpole.

A short sell signal occurs when the market price moves below the low of the third candle in the flagpole.

 

In this example a bullish Pennant pattern appears. The pennant is a single inside candle. The buy signal occurs when the market price candle goes above the high of the last candle of the flagpole.

When to close a position?

The Pennant pattern strategy combines two different stops and a profit target. The profit target is 5 times the average true range (ATR). This is fairly wide and serves to capture even the biggest break-outs.

The two stops to protect the position are a fixed stop and a trailing stop. The fixed stop is placed either on the low (for a long position) of the second candle in the flagpole or the high (for a short position) of the second candle in the flagpole. The trailing stop is 5 times the average true range (ATR) calculated over 60 periods.

Attention: the NanoTrader Full trading platform allows users to enter many stop types in parallel. The platform will at any time use the safest stop i.e. the stop which would lead to the smallest loss. So trailing stop becomes the active stop when its level moves above the level of the fixed stop.

 

This example shows a bearish Pennant pattern. A short sell position is opened. However, the market turns and the stop is hit. The position is closed with a loss.


 

This example shows a bullish Pennant pattern. A long position is opened. The market goes up but does not reach the objective (green line). The market goes down again and the position is stopped out. The loss is small because by that time the trailing stop had moved up significantly.


 

This example shows a bullish Pennant pattern. A long position is opened. The target is reached and the position is closed with a profit.

 

Conclusion

The Pennant pattern strategy is a day trading strategy. The strategy focuses on short, sharp price break-outs. This focus makes it useful for the forex markets. Signals are rare. About two or three signals per instrument per week is the norm. Traders using this pattern should work with multiple instruments. Although this strategy is explained here on the basis of 10-minute charts, swing traders can easily put their charts on 1-day and also use the pattern. In this case it is probably advised to use the Scripts functionality in the platform to detect the signals every morning.

Practical implementation

In NanoTrader Full follow these steps:
  • Choose the instrument you wish to trade.

  • Open a chart with the template study "WHS Pennant".

  • Semi-automated trading? Simply activate the TradeGuard+AutoOrder or the AutoOrder function.