One of the most basic points about price momentum is that no asset sees prices solely rise or fall. Instead, over time, asset prices ebb and flow higher and lower. With the emphasis on timing positions, it is really important to understand how a move in one direction is later accompanied by a pullback or a correction before a resumption of the directional momentum. Chasing after momentum is unwise as this is often the way to catch tops or bottoms in price. Instead, by waiting for the pullback, especially after the emergence of continuation patterns, trading can be accompanied by greater certainty when on the verge of establishing bullish or bearish positions. Two popular continuation patterns that help to verify the trend is set to continue are technical flags and pennants.
The emergence of a flag pattern closely resembles its namesake; a rectangular flag. Although it can occasionally be viewed within the comparable context to an equidistant channel formation, a flag pattern marks a period of consolidation before a resumption of the prevailing trend. Flag patterns break down into bullish and bearish varieties, with the key to establishing that the price action is indeed shaping up in a flag formation determined by the prior price action.
A bullish flag pattern would be characterized by a preceding bullish trend, a downward trend channel which is the flag, followed by an upside breakout that marks the continuation of the trend. Conversely, the bearish flag pattern would be depicted by a prevailing downtrend before an upward trending channel that invariably sees prices breaking lower after a brief period of consolidation within the channel.
Unlike the flag pattern which is similar to an equidistant channel formation, the pennant resembles a symmetrical triangle consolidation, or the convergence of two trends over a shorter period of time. Typically a pennant occurs within a time period that lasts between several days and several weeks. Similar to the flag pattern, the price action leading up to the formation of the pennant and how it responds directionally after the breakout is critical to confirming that the setup is indeed a pennant.
A bullish pennant pattern would be formed by a pullback from prevailing uptrend that leads to an upside breakout after the consolidation and a continuation of the upward trend. By comparison, a bearish flag pattern is characterized by a downward trend in an assets price that experiences an upward correction resulting in a consolidation that eventually leads to a downside breakout from the pennant triangle.
Strategizing For The Breakout
With both the flag and pennant patterns, the key to successfully taking advantage of the setups comes down to having the patience to wait for the breakout. In each case, whether the flag or the pennant, trading the range or consolidation does not offer as attractive reward conditions as the breakout momentum. As a result, a candlestick close outside the flag or the pennant that is in the same direction as the trend prior to the emergence of the pattern would be considered a breakout.
After a candlestick close is witnessed, it marks the optimal time to establish bullish or bearish positions depending on how the trend behaved prior to the setup. If the price action reverses, moving against the earlier trend after breaking out, this represents a breakdown in the continuation pattern and gives a good indication that the time has arrived to evaluate other opportunities.
These particular continuation patterns have a tendency to appear after a big move in the price of an asset, forming the pullback before the resumption of the trend. Confirmation of continuation is a key element, with breakouts confirmed by added momentum and additionally by higher than average trading volumes. These patterns typically only last a matter of weeks, with the most effective period considered between 1-3 weeks. Any pattern that is longer or shorter than the prescribed period should be viewed with increased scrutiny.