Here’s an example of one of the patterns I like a lot.
The pennant formation is characterized by a large volume spike in price over a few days followed by consolidation where price converges and volume diminishes often resulting in a breakout in the direction of the previous trend.
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See, you don’t buy the stock unless it breaks out of the pennant to the upside. When it does, the stop is nice and tight.
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Technically speaking, a bullish pennant is a sharp, strong volume rally on a positive fundamental development, several days of narrowing price consolidation on much weaker volume followed by a second, sharp rally to new highs on strong volume
Why Does It Happen?
Bullish pennants are very close cousins to bull flags, in fact, there is only one major difference, the consolidation after the flag pole is triangular (pennant-shaped) as opposed to being parallel (flag-shaped). Like flags, pennants are favored among technical traders because they almost always lead to large and predicable price moves. Finally, like flags, pennants usually take shape at the mid point of a major move higher. The first part of the pennant pattern is often called the flagpole or mast. During this phase the stock price skyrockets to a reaction high on some positive fundamental development.
Very often this will be the unveiling of a new product, a favorable legal resolution or a positive earnings surprise but the change in price is near vertical as would be sellers are overwhelmed by new buyers caught-up in the euphoria of the moment. As the stock soars speculators that were smart enough to have purchased the stock at lower levels begin selling. At this point the second phase or pennant portion of the pattern begins.
Because the flow of news and investor sentiment is overwhelming positive, most of the stock sold by speculators is easily absorbed in the beginning but as time passes fewer investors seem willing to pay the current price. Slowly, the stock price begins to falter on dramatically reduced volume. The descent is slow because bullish sentiment is still very strong and after several days of minor weakness, a brief rally begins and a minor low is set
Sensing an opportune time to enter new positions buyers begin to return, pushing the stock very near the most recent high but because volume is light this rally is easily rebuffed and a slightly lower high is established before the price turns lower. The new round of selling sends the stock modestly lower on reduced volume. After several more sessions the stock approaches the lows made at point but volume expands and a higher low is set at point.
This higher low establishes the parameters of a very small symmetrical triangle pattern. As the stock begins to move higher from point volume increases dramatically, buyers overwhelm those taking profits. Over the next 1-2 sessions the stock moves through the high set at point and volume surges further. This triggers an upside breakout. The next session several Wall Street firms either make new "buy" recommendations or reiterate existing recommendations. The stock opens higher and goes on to make significant new highs in the weeks ahead.
When I find this pattern on a stock I put it on a watchlist so I can follow it a lot closer. In the case above it looks like the stock is going decide which way it breaks within a few days however many pennants can take a lot longer to play out. I want to follow closely and look for entry on a white candle breaking up through the top of the downtrend line of the formation.
It might be wise to take 1/2 a position on that break and then wait for the confirmation which would be a break above the previous day high.
I might place a "buy stop limit order" at the breakout point that will get filled if I am away from the screen.
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