Trading the Pennant chart pattern is a trading strategy that can lead to quick gains but are harder to find than Flag patterns. Pennants require a small triangle to form after a quick sharp rally. The rally might be only a couple of days but can be up to a couple of weeks. The small triangle is often only a couple of days but can be over a week. When Pennant patterns occur in strongly uptrending stocks they provide a good trading opportunity for the swing trader.
The Pennant chart pattern in a strong uptrend is illustrated with a sample trade in Bristol Myers Squibb Co. NYSE:BMY as shown below in Chart 1.
Chart 1. Swing trade setup for BMY
Chart by stockcharts.com
The sample trade for BMY shows a stock in a strong uptrend. The 50-day SMA (simple moving average) is sloping upwards and BMY has a short strong rally on increasing volume and then pauses for two days on declining volume to form a Pennant pattern.
Should BMY trade above the high of the setup day (last day in the Pennant) then an entry could be taken.
Swing traders using end-of-day data tend to use stop buy orders to be executed the next day if the stock trades above the setup day’s high. A stop buy order is simply a stop-loss order used in reverse. The order is only activated if the stock trades above the trigger price – which can be set 0.20 above the setup day’s high. The stop buy order can be either a market order or a limit order. With a limit order the trader knows the price they will pay but if the stock gaps up the order may not be filled.
The alternative is to wait until the next trading day is complete and see if the stock traded above setup day high – if it does then a buy order to enter is placed the following day.
Some swing traders monitor the markets live during the trading day and they simply place a buy order when the stock trades above the trigger price.
A stop buy limit order would likely be filled at around 43.60
The initial stop can be placed below the setup day’s low at around 42.20 to allow some wiggle room.
Generally swing traders use tighter initial stops than position trades as swing traders are only after the first rally and if the rally fails then the trade is exited.
To determine whether a swing trade in BMY is worth taking, the swing trader should evaluate the risk-reward.
The risk is easy to determine as it is simply the initial stop which is 42.20.
The reward can be estimated by adding the height of the Pennant (45.70 – 39.30 = 6.40) to the apex of the Pennants triangle. This gives a likely rally to (43.00 + 6.40 = 49.40).
The risk-reward for a proposed trade in IOC can now be determined.
Likely entry price of 43.60 and an initial stop of 42.20 with a profit target of 49.40 gives:
Profit = 49.40 – 43.60 = 5.80
Risk = 43.60 – 42.20 = 1.40
Risk reward ratio = 5.80 / 1.40 = 4.1
With a risk-reward of 4.1 this is a trade worth taking as the swing trader stands to make around four times the dollar amount risked.
The trade can be managed using the prior day’s Low trailing stop method since the stock is expected to rally strongly after the quick pause with the Pennant.
The entry and exit for the BMY trade is shown below in Chart 2.
Chart 2. Swing trade entry and exit for BMY
Chart by stockcharts.com
The trade with BMY using the prior day’s Low trailing stop method stops the swing trader out before the profit target is reached.
When using trailing stops there is always the chance that the trade is stopped out before the profit target is reached. If the trader does not exit at their stop, then there is always the chance that the stock trades all the way back down and triggers the initial stop, thus turning a profitable trade into a losing trade.