Don't leave your trading strategy flapping in the breeze.Source: StockCharts.com. Annotations by Encyclopædia Britannica. For educational purposes only.Even when a stock, cryptocurrency, commodity, or other security is clearly trending in one direction, it may occasionally reverse course for several periods before resuming the prevailing trend. This price action creates patterns called flags and pennants, which technical analysts use to spot a temporary pause before a trend resumes.

　　Both patterns offer opportunities for traders who are looking to enter or add to a position, set a stop-loss order, and/or capitalize on a short-term day trade or longer-term swing trade. Let’s look at how to spot flag and pennant patterns on a chart and understand the market psychology that drives them.

　　Anatomy of a flag patternFlags occur within a trending market (up or down). On a chart, they look like rectangles that tilt against the prevailing trend. The flag is marked by price moves that are roughly parallel, as highlighted by top and bottom trendlines that form what technicians call a “channel.” See figure 1.

　　A steeper pole signifies a more pronounced pattern. In figure 1, note how the flag’s rectangular shape is tilted against the prevailing trend. The upper and lower trendlines are nearly parallel.

　　Figure 1: FLAG DAYS. After a strong uptrend, the stock entered a consolidation phase—six sequential down periods of roughly the same width—before resuming the uptrend.Source: StockCharts.com. Annotations by Encyclopædia Britannica. For educational purposes only.Bull flags and bear flagsFlag patterns that take place within an uptrend are called bull flags because the presumed trend continuation is toward the upside. Bull flags tilt downward, as they are formed when prices pull back amid a downtrend.

　　In a downtrend, flag patterns are referred to as bear flags, as the presumed trend continuation is to the downside. Bear flags tilt upward, marking a temporary rally amid a strong downtrend.

　　The psychology behind the flag patternIn a strong uptrend, the top part of a flag takes shape when buyers begin taking profits. The pool of new buyers shrinks. As prices pull back, potential sellers are hesitant to take action in large numbers. This leads to a slight decline, as only a limited number of buyers and sellers are opening new positions or closing out existing positions.

　　As the flag is forming and extending, bulls and bears are in a temporary state of equilibrium. Neither can decide whether a stock’s price at the moment should be significantly higher or lower. Eventually, buyers decide that the stock’s decline might just be a “breather” rather than a true reversal. Bulls regain confidence in the prevailing trend; buyers (new or existing) purchase enough shares to push prices upward and out of the consolidation range (marking a “breakout”) and take control of the market.

　　In a strong downtrend (where a flag is a bearish continuation pattern), the opposite is true, with short sellers gaining control of the market and leading to a breakout to the downside.

　　Anatomy of a pennant patternPennants also occur within a trending market (up or down). On a chart, a pennant looks like a small symmetrical triangle, with price ranges becoming more and more narrow toward the end of the formation. The “pole” of a pennant pattern is often unusually steep, indicating a sharp price surge. In figure 2, note that the flagpole consisted of a jump in price before the market’s open, creating a sharp price gap. After pulling back, prices continued to trend sideways, forming a triangle.

　　Figure 2: WINNING THE PENNANT RACE. After a sharp rally (perhaps on a news event such as an earnings release), the share price moves down, then sideways, in a smaller and smaller price range, until shares “break out” of the pennant.Source: StockCharts.com. Annotations by Encyclopædia Britannica. For educational purposes only.The psychology behind the pennant patternAfter a strong price surge, some traders close positions to take profits. A pennant scenario is similar to that of a flag, but because of the strength and suddenness of the price jump (“flagpole”), there’s even more hesitancy among bulls and bears to open new positions once prices begin to pull back.

　　This heightened hesitation to buy or sell results in a drop in trading volume and volatility. As traders adopt a wait-and-see stance on the market, trading volume shrinks. Nevertheless, tension builds, as bulls and bears are eager to pull the trigger once price breaks out from the range.

　　When prices break out in the direction of the prevailing trend, it confirms the expectations of those trading in that direction. In figure 2, buyers took control of the market as soon as prices broke out above the pennant’s narrowing range.

　　Note that in a strong downtrend (where a pennant is a bearish continuation pattern), the opposite is true, with short sellers gaining control of the market.

　　Ideal markets for spotting flags and pennantsIf you’re looking for these patterns, you’re likely to find more flags than pennants, as the conditions required for pennants occur less frequently. Look for markets exhibiting two characteristics:

　　High liquidity. Because the mark of a pennant—and to a lesser extent, a flag—is an observable decline in volume, the setup is most pronounced in listed securities with high average daily volume and tight bid-ask spreads.  Strong trend. A strong trend, often with increasing volume, contributes to the forming of flagpoles.With that in mind, you might look for flags and pennants in the following markets:

　　Stocks in high-volume sectors like information technology, consumer discretionary, and energy.Major forex pairs, such as the euro vs. the U.S. dollar (EUR/USD), that are highly traded in the global economy on a 24-hour basis.High-demand commodities like oil and gold that play a significant role in the global economy.Cryptocurrencies like Bitcoin and Ethereum that are not only popular among traders and investors, but are also making inroads as safe haven alternatives to fiat currency.As with any chart pattern, flags and pennants don’t always work and can never guarantee an outcome. However, they do provide a structure to help plan your trade, whether price moves in your favored direction or against it. It might also help to use other indicators to gauge volume, momentum, and fundamentals when planning your trades.

　　Additional tips for trading flags and pennantsWatch the tilt. Flags that tilt in the direction of the prevailing trend may not be as reliable as when they tilt against the trend. A flag that tilts with the trend may signal weakening momentum and less tension for a strong breakout.

　　Pennants ideally don’t tilt. When they do, a tilt against the direction of the prevailing trend may prove more reliable for the same reasons.

　　Use the breakout point to determine entry points. If you’re initiating the trade with a long position, place an order either as prices break above (if you’re a day trader watching every tick) or close above the pattern’s upper trendline (if you’re a swing trader looking for a longer-term trade). If you’re initiating with a short position, you’re looking for a breakout on the downside.

　　Use the flagpole to set a profit target. Many flag and pennant traders calculate the height of the entire formation, from the beginning of the flagpole to the top (or bottom, if in a downtrend) of the flag or pennant, and use that as a profit target. For example, in figure 2, the flagpole is roughly $15 high (from $172 to $187). Assuming you bought right at the pennant’s breakout (at $182), your profit target might be ($182 + $15) = $197.

　　And because a trader should always pair a profit target with a loss limit, you may also consider setting a stop-loss order a few points below the lowest part of a pattern’s lower trendline (or the nearest support level below that).

　　The bottom lineFlags and pennants are consolidation patterns that indicate the continuation of a trend. If you identify and use them correctly, they can offer clear signals for entries and exits. Confirming these patterns with volume and momentum analysis can increase your odds of a successful trade. Just remember they work best in trending markets that trade with high liquidity.