A diamond pattern is used for detecting reversals. Once rightly identified, it is one of the most profitable patterns for using reversals for trading strategy.
Diamond chart formation is a rare chart pattern that looks similar to a head and shoulders pattern with a V-shaped neckline. Diamond chart patterns usually happen at market tops.
What is ‘diamond’ pattern?
A bearish diamond formation or diamond top is a technical analysis pattern that can be used to detect a reversal following an uptrend; however bullish diamond pattern or diamond bottom is used to detect a reversal following a downtrend.
This pattern occurs when a strong up trending price shows a flattening sideways movement over a prolonged period of time that forms a diamond shape.
Detecting reversals is one of the most profitable trading opportunities for technical traders. A successful trader combines these techniques with other technical indicators and other forms of technical analysis to maximize their odds of success.
Formation of the diamond pattern
Diamond chart pattern is characterized by four limited trend lines representing, two support lines below and two resistance levels above which respectively connect the most recent lows and highs. The price fluctuations initially widen and then narrows in the chart pattern.
Adding a price oscillator such as moving average convergence divergence and the relative strength index can increase the accuracy of your trade as these tools can gauge price action momentum and be used to confirm the break of support or resistance.
Although the bearish diamond top has been overlooked due to its infrequency, it remains very effective in displaying potential opportunities for short selling.
A) Trading with bullish diamond
> “Quick rise is often replaced with quick fall” is a compensating quality of the diamond bottoms pattern.
> Diamond Buy Signal - The breakout of the diamond appears when the price goes through the lower right side downward sloping trend line.
> Targets: To calculate the breakout potential for a diamond formation, take the distance between the highest and lowest point in the diamond formation and add it to the breakout point. However, in most occurrences a breakout from the diamond chart formation will carry stocks much further.
> SL: Immediate swing low before breakout is considered as a stop loss for long trades.
B) Trading with bearish diamond
> Diamond Sell Signal - The breakdown of the diamond appears when the price goes through the lower right side upward sloping trend line.
> Targets: To calculate the breakout potential for a diamond formation, you will want to take the distance between the highest and lowest point in the diamond formation and add it to the breakdown point. However, in most occurrences a breakdown from the diamond chart formation will take stocks much lower.
> SL: Immediate swing high before breakdown is considered as a stop loss for short trades.
Conclusion
> Identifying trend reversal for profitable trades becomes simpler with Diamond Patterns. The diamond pattern has a reversal characteristic. Bullish Diamond Pattern is also called as Diamond Bottom and Bearish Diamond Pattern is called as ‘Diamond Top’
> Diamond Chart pattern is characterized by four limited trend lines representing, two support lines below and two resistance levels above which respectively connect the most recent lows and highs.
> Adding a price oscillator such as moving average convergence divergence and the relative strength index can increase the accuracy of your trade
(The author is Head - Technical & Derivative Research at Narnolia Financial Advisors Ltd.)
Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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