I've noticed that many traders underestimate one of the most effective technical analysis patterns. I'm talking about the pennant pattern—a consolidation figure that appears in the middle of a trend and provides an excellent entry signal.

The pennant pattern forms after a sharp price movement up or down, when the quotes start trading within a narrow range, taking the shape of a small symmetrical triangle. This occurs roughly halfway through the developing trend. It is most commonly found on short-term timeframes but can appear on all intervals.

The structure is quite simple. First, there is a sharp rise or fall—this is the flagpole. Then, the price enters a consolidation phase where the upper and lower trend lines converge at a point, forming a triangle. Pennants resemble flags, but the main difference is that pennants are smaller in size and require a more aggressive preceding move.

When the price breaks through the boundary of the pennant pattern, it signals an entry in the direction of the trend. A proper pennant should form within a couple of weeks, at most three. If it takes longer, it is likely to turn into a larger pattern or a reversal may occur.

An important point is volume. During the formation of the pennant, volume should decrease, but after the breakout, it should spike sharply. This indicates that the market is truly ready to continue the movement.

Interestingly, John Murphy in his classic book on technical analysis calls the pennant pattern one of the most reliable continuation patterns. However, research by Thomas Bulkovski showed more modest results. He analyzed over 1,600 examples and found that the failure rate of breakouts is about 54%, and the success probability is around 35-32%, depending on the direction. The average move after the signal is about 6.5%.

These numbers are not the most impressive, but they confirm the importance of risk management. Many traders use the pennant pattern in combination with other technical analysis tools to increase their chances of success.

There are bullish and bearish pennants. A bullish pennant forms in an uptrend and signals the continuation of growth. A bearish pennant appears in a downtrend and indicates further price decline. The trading approach is the same—enter on the breakout in the trend's direction, only for a bullish pennant, open a long position; for a bearish one, go short.

There are several entry options. You can enter immediately on the breakout of the pattern boundary or wait for a pullback and continuation of the move. The target is measured by the distance from the start of the flagpole to its peak or base, which is then projected from the breakout level.

The stop order is placed slightly above the resistance line for a bearish pennant and slightly below the support line for a bullish one. This helps limit losses if the pattern fails.

The main advantage of the pennant pattern is that it is a short-term figure. The breakout should occur within three weeks; otherwise, the pattern loses its strength. This means you won't be waiting months for a result.

The key to success is the quality of the preceding trend. If there was a sharp and steep move before consolidation, the pennant breakout will likely be more powerful. Aggressive trading that created the flagpole usually continues after the breakout.

Overall, the pennant pattern is a time-tested technical analysis tool. Not a cure-all, but when used correctly and combined with other methods, it can be useful for trading.