The Difference Between a Wedge and a Pennant in Trading

Understanding the Difference Between a Wedge and a Pennant in Trading

In the dynamic world of trading, the ability to read and interpret chart patterns is an invaluable skill. Among the myriad of patterns traders observe on charts, two that often cause confusion are the wedge and the pennant. Both are continuation patterns, which means they are typically followed by a movement in the same direction as the trend prior to the pattern forming. However, they have distinct characteristics that can signal different outcomes.

The Wedge Pattern

A wedge pattern forms when the price of an asset consolidates between two converging trend lines. This pattern is characterized by a narrowing price range as the asset makes higher lows and lower highs, coming to a point where the two trend lines converge. Wedges can be classified into two categories: rising wedges and falling wedges.

• Rising Wedge: This pattern occurs in an uptrend and suggests a bearish reversal. The rising wedge is identified by a slope up with the price consolidating upwards. Despite the higher highs, the upward momentum is losing steam, and a downward breakout is typically expected.

• Falling Wedge: Conversely, a falling wedge appears during a downtrend and indicates a bullish reversal. The pattern slopes down, and as the price consolidates, it makes lower lows and lower highs. The falling wedge predicts an upward breakout, signaling that the downtrend may be coming to an end.

The Pennant Pattern

The pennant pattern resembles a small symmetrical triangle that begins wide and converges as the pattern develops, much like a pennant on a flagpole. It is formed by a sharp movement in price, known as the flagpole, followed by a consolidation period with converging trend lines, and then another sharp movement in the same direction as the flagpole. Pennants are typically short-term patterns that last from one to three weeks.

• Bullish Pennant: After a significant upward move, the price consolidates, creating a small symmetrical triangle. The expectation is a continuation of the uptrend once the price breaks out of the pennant formation.

• Bearish Pennant: Following a sharp decline, the price action consolidates and forms a pennant. The pattern suggests that the price will continue to fall once it breaks out of the consolidation.

Key Differences

While both patterns indicate a continuation of the current trend, their formations and implications are different:

• Duration: Wedges can form over a longer period, from a few weeks to several months. Pennants, on the other hand, are short-term patterns that develop quickly and are resolved in a few weeks.
• Shape: Wedges have a more pronounced slant upwards or downwards, while pennants are typically more horizontal, resembling a small triangle.
• Volume: In a wedge pattern, the volume typically diminishes as the pattern progresses. For pennants, the volume spikes during the creation of the flagpole, decreases during the formation of the pennant, and increases again upon breakout.

Trading Strategies

Traders often use these patterns to make decisions:

• Entry Point: For wedges, traders may look for a breakout from the trend lines to enter a position. With pennants, the entry point is typically after the price breaks out from the pennant formation, continuing the direction of the trend.
• Stop Loss: A common strategy is to place a stop loss just outside the opposite side of the pattern from the breakout to minimize potential losses.
• Profit Target: Traders might set a profit target by measuring the height of the beginning of the pattern and projecting that distance from the breakout point.

Conclusion

Recognizing the difference between a wedge and a pennant can significantly enhance a trader's ability to make decisions. While both are continuation patterns, understanding the nuances of each can lead to more informed trading decisions and potentially greater profits. As with all trading strategies, it's important to consider additional factors such as market conditions, volume, and other technical indicators before making a trade.

References: CMT Level I Curriculum 2022, P. 148,149,150,151