Flags and pennants are two distinct trend continuation price patterns that bear close resemblance to each other. A flag looks like a rectangle, while the pennant has a more triangular shape.
Both of these cryptocurrency chart formations typically appear after sharp price moves, and represent small consolidation areas, before prices break out in the direction of the original trend.
Flags and pennants can last from anywhere between a few hours to a few days, making them useful for both intraday strategies as well as swing trading. The volume, as with most successful pattern breakouts, should be substantial to confirm the validity of the signal.
A flag looks like a small rectangle that should ideally slope opposite to the preceding trend. If the prior price move was up, the flag should have a downward slant, while if the earlier move was down, the flag should slope higher. Since flags are generally regarded as short-term price formations, they don’t tend to have reaction highs or reaction lows, with prices remaining sandwiched between two parallel trend lines.
To be deemed a valid continuation pattern, a flag should appear after a big, quick move. These price movements may contain price gaps, and often represent the first or second leg of a major market shift. The flagpole is an integral part of the pattern and is defined as the distance between the flag high/low and the preceding support/resistance level.
In case of a bullish flag pattern, a close above the high of the pattern indicates that the prior up trend has resumed. For a bearish flag pattern, a break down below the low of the pattern signals the resumption of the previous bearish trend.
Volume should be closely monitored during the formation of the pattern. It should be heavy during the steep price advance or dip that constitutes the flagpole. When the actual flag consolidation is materializing, volume dries up to reflect the lack of active market participation. The price target after a breakout from the flag pattern is formulated based on the length of the flagpole on the cryptocurrency chart, with this distance applied to the top or bottom of the pattern.
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A pennant closely resembles a symmetrical triangle, but is much smaller in size. The pattern structure starts out wide, but begins to converge like a cone, depicting extreme price consolidation. Unlike flags, the slope of the pattern is not important, and can be horizontal, upward or downward.
Due to its small size, a pennant does not have clearly demarcated reaction highs and reaction lows over which trend lines can be imposed. However, what is important is that price action should be contained within two converging lines. The pennant also contains a flagpole, which is equal to the distance from the first broken resistance or support zone to the high or the low of the pattern.
To be considered a valid continuation pattern, the existence of a strong prior trend is mandatory. The steeper the preceding price move, the greater the significance of the pennant pattern, and the subsequent breakout.
In case of a bullish pennant, a strong close above the formation high signals the bullish trend has resumed. For a bearish pennant, a close below the low of the pattern indicates the preceding down trend has been restored.
The volume criteria are same as those of the flag pattern, with the flagpole drawing significant market participation, which then dries up as the pennant gets plotted. The target price for the pennant formation is determined by the length of the flagpole, applied to the pattern resistance or the support that is breached.
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Important Points to Note About Flags and Pennants
- Flags and pennants occur in both up trends and down trends
- In case of upward trends, traders should focus on generating returns from bullish breakouts because initiating shorts during an uptrend presents a worse scenario in terms of risk compared to potential reward
- Look for volume confirmation during breakouts to increase the likelihood of spotting a real breakout and not a false move
- Since flag poles can be quite long, and the size of the flag or pennant pattern quite small, the resulting trades offer highly favourable risk-reward ratios
The Final Word
Even though flags and pennants are frequently-occurring patterns, the identification guidelines should be followed strictly. It is important that flags and pennants be preceded by a sharp price move. Without that, the reliability of the formation becomes questionable.