The Most Predictable Pattern

While there is no such thing as a sure thing in trading some market formations are much more predictable than others. One such formation is the pennant, or symmetrical triangle.

The pennant formation usually forms as the market makes a tighter and tighter range resulting in a formation that resembles a pennant flag, with the larger “mast” area of the pennant on the left and the point of the flag on the right. Basically a market forms a pennant when it is uncertain which way it will go. These periods of market indecision, or consolidation, can sometimes occur the week before an important market report is due. Other times a pennant can form just because the bulls and bears are so evenly matched that neither side has the ability to determine market direction. Whatever the underlying reason for a pennant forming all markets are capable of forming pennants and pennants can be found on daily, weekly and monthly charts.

Trading a pennant formation is as simple as going long if the prices break up and out of the pennant, or going short if prices break down and out. Similar to channel trades, one side of the trade is used as the entry order and the other side of the trade is normally used to place the exit order. When a market breaks out of a pennant formation it will usually move at least a distance equal to the mast of the pennant. This rule of thumb is helpful when trying to determine where to take profits or place stops.

There are variations on the symmetrical pennant formation known as the ascending and descending triangles, as well as the inclining and declining wedge.

A descending triangle is a pattern where prices consolidate by making lower highs while exhibiting support at the lows. This pattern usually shows downward pressure on the market and it is not uncommon to see a bearish breakout. The opposite is the case for ascending triangles where the market has a firm high but continues to make higher lows. This type of formation typically results in a bullish breakout.

The inclining wedge is a pattern that points up at an angle instead of forming a horizontal base like the ascending triangle. Unlike the ascending triangle however, this formation is considered to be bearish in nature so a breakout to the downside is often the result. Again the opposite is true for the declining wedge which would form on a downward angle. This formation is considered bullish and is usually traded by going long when prices break up and out of the wedge.

For more from Erich, visit the Indicator Warehouse for additional futures resources and NinjaTrader Indicators.