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Wednesday, January 9, 2008

BULLISH PENNANT PATTERN – Part 1: Formation

Like Bullish Flag pattern, Bullish Pennant is also a short term bullish continuation pattern that occurs during an uptrend, indicating a pause / small consolidation before continuing the uptrend.
This pattern normally appears following a sharp price increase on high volume.

The Formation of Bullish Pennant






Bullish Pennant pattern is usually preceded by a very steep (almost vertical) increase in price on heavy volume. This steep price increase makes the “Flagpole” of the pattern.
The sharp rise in price may occur due to positive market sentiments toward favorable events / developments, such as positive earnings surprises, new product launch, etc.

After the sharp increase, the price movement is then contained within two converging lines (wide in the beginning and narrowing as the pattern develops), forming a small symmetric triangle or “Pennant” shape, on decreasing volume.
The slope of the Pennant is usually neutral.
This pennant represents a brief pause / consolidation in the midst of an uptrend before resuming its upward movement.

The completion of the pattern occurs when prices break out to the upside through the resistance level (i.e. descending upper line) of the Pennant with a spike in volume. This would mark the resumption of the original uptrend.

The Psychology Behind The Bullish Pennant Pattern
A Bullish Pennant pattern takes place because prices seldom move higher in a straight line for an extended period. During a sharp price movement, prices will typically take brief pause periods to "catch their breath" before continuing their move.

During the 1st stage of the Bullish Pennant pattern (Flagpole part), as a result of positive market reactions toward some favorable events (e.g. positive earnings surprises, upward guidance, new product launch, etc.), prices keep on soaring sharply as new buyers, who were caught-up in the euphoria at that moment, are willing to buy at even higher prices.

As the prices rises, some early buyers who have bought the stock at lower levels would begin to sell to take profits. At this point, the 2nd stage of the Bullish Pennant pattern begins (i.e. the Pennant part).
At first, most of the stocks sold by the early buyers are easily absorbed, since the news and market sentiments are still very positive. Nevertheless, as time passes, buying pressures subside and the prices start to consolidate on contracting volume.

After some time, a new positive development comes out. As a result, the price begins to move higher and break out through the upper descending line of the Pennant with a surge in volume, as new buyers now overwhelm those taking profits.
In the following days, there might be more positive news and/or “buy” recommendations coming, leading the prices to lead to escalate even higher.

Continue to Part 2: Important Characteristics of Bullish Pennant pattern.

To read about other chart patterns, go to: Learning Charts Patterns.

Related Posts:
* Learning Candlestick Charts
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks

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