Diamond tops formation
A diamond top pattern does not occur too often, but when it appears it may be a sign of a strong trend reversal on the asset. It can be spotted when an upward trend starts flattening sideways.
So what does a diamond top look like? The sequence is the following:
- The price is trending upwards;
- It then starts fluctuating, with the peaks going higher and the troughs lower, at first;
- After that the price action changes with the peaks being lower and troughs – higher;
- Normally, connecting the highs and lows forms a diamond-like shape. Note that the diamond does not have to be symmetrical. It can be slightly tilted to the side, too.
A signal for an entry for the diamond top pattern is received when the price breaks through the bottom right support line (bottom of the diamond). It is the confirmation of the price reversal. Traders, depending on their approach, may also take advantage of the price fluctuations in the diamond before the price heads down. What’s important is to set a tight stop loss at the support level in order to possibly minimize potential losses.
Note that the diamond top pattern is often confused with the head-and-shoulders formation. Carefully assess the patterns in order to make an informed decision.
Diamond bottoms pattern
Opposite of the diamond tops is the diamond bottoms formation which occurs after a strong downward trend on a security or currency pair.
The price dropping into the diamond from above indicates that the pattern is a diamond bottom, not the top. The diamond represents the struggle between the buyers and sellers on the market: buyers push prices up to a new minor high until selling pressure forces prices back down. The widening pattern can continue for several swings but usually doesn’t last too long. A signal for a Buy entry is the price breaking through the resistance line upwards.
In case price breaks through the diamond bottoms pattern downwards, decreasing instead of increasing, a trader may consider looking for another pattern in such a case. A trader’s job is to find diamonds that lead to a price reversal. The key is trading with the trend: following the diamonds with an upward breakout in a bull market and downward breakout in a bear market.
Identifying a diamond shape on the chart may not always be easy: the key is to be looking for the shape after a strong upward or downward trend with a widening price range.
Conclusion
Trading diamond patterns may seem a bit complicated – this shape requires a sharp eye and lots of practice. However, learning to spot this pattern may be of use both for novice and experienced traders. Please note that no strategy or chart pattern can guarantee 100% success, so a strong risk management approach needs to be applied along with it.
