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Breakout Trading With Flags and Pennants

Kyle DennisKyle Dennis ·

If you’ve been around trading, you’ve probably heard of flag and pennant patterns before. However, for those who don’t know how these patterns work, they’re commonly known as continuation patterns that are related. That in mind traders use could use both flag and pennant patterns for both long and short entries.

Flag Pattern

You’ll typically see a flag pattern form, after a stock has had a strong trend higher, or lower. Now, keep in mind that flag patterns don’t always occur, and do not need to break higher. It’s just widely known that it could indicate bullish, or bearish, trading. That said, you would want to see volume rise and the price break above, or below, the short-term channel formed by the stock after the move higher. Let’s take a look at a flag pattern.

Take a look at the daily chart on the iShares S&P SmallCap 600 Index Fund (NYSEARCA: IJR).Source: TradingView

If you take a look at the chart above, you’ll notice some annotations. Here’s an example of a bullish flag pattern formation that broke out.

On the other hand, there are also bearish flag patterns, and it’s just the opposite of a bullish flag pattern. You’ll see the stock fall, then form a short-term uptrend and break lower. Let’s take a look at an example.

Shutterfly Inc (NASDAQ: SFLY) had a bearish flag formation between mid September 2016 and mid October 2016.Source: TradingView

If you look at the chart above, the stock dropped significantly in one day, and then caught a slight bounce and an uptrend. In this process, SFLY formed a bearish flag pattern. Consequently, if you saw this, you might have considered getting short the stock when it broke below the lower support trendline, as annotated.

When considering trading these setups, you would want to wait for confirmation, and make sure the breakout, or breakdown, candle closes above, or below, the resistance, or support, trendline, respectively. Again, these patterns could fail, but they are typically considered high-probability setups. 

 Pennant Pattern

The pennant pattern is another setup that technical traders might use. Again, the pennant pattern is similar to the flag pattern. However, the pennant pattern forms a triangle-like shape. Similarly, you might see the stock trend higher, or have a sharp move before consolidating, then either break higher, or lower, depending on whether it’s a bullish or bearish pennant. Let’s take a look at two examples now.

Abraxas Petroleum Corp. (NASDAQ: AXAS) formed a bullish pennant pattern, as shown in the daily chart below.Source: TradingView

Now, notice how the stock had over a 40% rise, and thereafter, it consolidated and formed a bullish pennant. Thereafter, the stock broke above the resistance area with some volume, and rose over 30% at one point. Therefore, if you were anticipating this move and were bullish on the name, you could have considered getting long the stock on the breakout.

On the other hand, Bluerock Residential Growth REIT Inc (NYSEMKT: BRG) formed a bearish pennant pattern, as shown below.Source: TradingView

Here, you’ll notice Bluerock Residential Growth REIT Inc (NYSEMKT: BRG) moved lower, and then consolidated. Thereafter, it broke below the trendline, and traded over 1 point lower. That said, if you were following this and set an alert, you could have potentially shorted the stock and profited, depending on your execution and timing.

Final Thoughts

Flag and pennant patterns could prove to be profitable strategies, but you have to know what to look for, and your timing must be near perfect. Additionally, you’ll need to know how to properly risk manage and set stop losses, in case the pattern fails. With technical trading, you’ll need to study these patterns and do your homework until you have these patterns ingrained in your memory, and you’ve figured out how to spot them once you look at a chart.

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