First, let's look at the Flag pattern:
In the illustration above, you can see the flag pattern forms after a steady trend in market value in one direction—in this particular case, the trend is upward. Investors will test the trend with buying and selling patterns that form small peaks and valleys in the opposite direction of the preceding trend—in the figure above, the flag represents an overall, but short-lived, downward trend. The peaks and valleys of these fluctuations can be bracketed by straight and non-converging parallel lines, thus forming the rectangular “flag” shape. Even though the flag pattern shows a momentary decline in market value, it doesn't really represent a permanent downturn. Once the flag pattern is fully formed, the price trend continues in the direction it was previously headed—in this case, upward. The illustration here depicts an upward-trending, or “bull,” market.
Next up is the Pennant pattern:
Much like the flag pattern, the pennant represents a short-term “hiccup” in market value, which ultimately returns to the trend that was already being formed beforehand—again, in this case, the image represents an overall upward trend. The momentary reversal, or stagnation, of the upward trend in the illustration above is less sharp and defined as it is in the flag pattern, so the lines bracketing it are convergent and more triangular in shape, as in that of an actual pennant. In fact, the pennant pattern is considered a miniature version of a “symmetrical triangle” chart pattern (for more information on triangle patterns, please refer to our Identifying and Interpreting Triangle Chart Patterns article on that subject). Much like the flag pattern illustration, this representation of a pennant pattern depicts a bull market.
With both the flag and pennant patterns, they follow a fairly robust trend in one direction; this sharp and almost straight trend line forms the “mast” or “flagpole” of the pattern. The patterns themselves represent a brief testing, or correction, of the market. Once investors see the trend is justified, it will continue in the same direction. The movement in the opposite direction is only temporary, so neither pattern is considered a “reversal” type. Since the preceding trend returns after the flag or pennant becomes apparent, both patterns are categorized as “continuation” types. Only in very rare cases do flag or pennant patterns show a reversal in overall market value; as a matter of fact, when this happens, many analysts don't consider them true flags or pennants.
Flags and pennants tend to be short-term patterns, and usually take place over the space of one to three weeks, as opposed to other patterns, which can take up to a year to fully form. Many industry analysts claim these patterns are created by overreaction by new investors to momentary good or bad news. This spate of buying and selling is soon corrected, and doesn't ultimately affect the current value trend of the stock or commodity.
Finally, we'd like to point out that flag and pennant patterns can represent “bull” (upward-trending) and “bear” (downward-trending) markets. Both the illustrations in this article show patterns that indicate bull markets. However, there are inverted flag and pennant patterns that—following a value trend that is already headed in a downward direction—momentarily move upward before continuing back downward again. As a general rule of thumb, investors tend to sell when the market is high and buy more shares when the price is low. As such, decisions to buy and sell rarely take place with experienced investors during flag or pennant periods; they often wait for the trend to continue in whichever direction it was initially headed before making their move.
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