Flags and Pennants

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Flags and Pennants
Flags and Pennants are short-term continuation patterns that mark a small
consolidation before the previous move resumes. These patterns are usually
preceded by a sharp advance or decline with heavy volume, and mark a
midpoint of the move.

Sharp Move: To be considered a continuation pattern, there should be
evidence of a prior trend. Flags and pennants require evidence of a sharp
advance or decline on heavy volume. These moves usually occur on heavy
volume and can contain gaps. This move usually represents the first leg of a
significant advance or decline and the flag/pennant is merely a pause.

Flagpole: The flagpole is the distance from the first resistance or support
break to the high or low of the flag/pennant. The sharp advance (or decline)
that forms the flagpole should break a trend line or resistance/support
level. A line extending up from this break to the high of the flag/pennant
forms the flagpole.

Flag: A flag is a small rectangle pattern that slopes against the previous
trend. If the previous move was up, then the flag would slope down. If the
move was down, then the flag would slope up. Because flags are usually too
short in duration to actually have reaction highs and reaction lows, the
price action just needs to be contained within two parallel trend lines.

Pennant: A pennant is a small symmetrical triangle that begins wide and
converges as the pattern matures (like a cone). The slope is usually
neutral. Sometimes there will not be specific reaction highs and lows from
which to draw the trend lines and the price action should just be contained
within the converging trend lines.

Duration: Flags and pennants are short-term patterns that can last from 1 to
12 weeks. There is some debate on the timeframe and some consider 8 weeks to
be pushing the limits for a reliable pattern. Ideally, these patterns will
form between 1 and 4 weeks. Once a flag becomes more than 12 weeks old, it
would be classified as a rectangle. A pennant more than 12 weeks old would
turn into a symmetrical triangle. The reliability of patterns that fall
between 8 and 12 weeks is debatable.

Break: For a bullish flag or pennant, a break above resistance signals that
the previous advance has resumed. For a bearish flag or pennant, a break
below support signals that the previous decline has resumed.

Volume: Volume should be heavy during the advance or decline that forms the
flagpole. Heavy volume provides legitimacy for the sudden and sharp move
that creates the flagpole. An expansion of volume on the resistance
(support) break lends credence to the validity of the formation and the
likelihood of continuation.

Targets: The length of the flagpole can be applied to the resistance break
or support break of the flag/pennant to estimate the advance or decline.

Even though flags and pennants are common formations, identification
guidelines should not be taken lightly. It is important that flags and
pennants are preceded by a sharp advance or decline. Without a sharp move,
the reliability of the formation becomes questionable and trading could
carry added risk. Look for volume confirmation on the initial move,
consolidation and resumption to augment the robustness of pattern
identification.

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