In the financial markets, the diamond pattern is an advanced chart shape. It’s a less well-known option among technical traders and investors. As a result, many traders are familiar with its structure and trading software. We’ll go over the specifics of detecting and trading the diamond pattern in this lesson.
What is Diamond Chart Pattern?
The diamond chart pattern belongs to the family of traditional chart patterns. However, unlike the flag, pennant, head and shoulders, and rectangle patterns, the diamond chart pattern occurs on the price chart less frequently. As a result, trading the diamond chart pattern is less common than other patterns. Nonetheless, technical traders should learn this pattern as it might present a familiar trading opportunity if detected early.
The head and shoulders chart pattern is sometimes confused with the diamond chart pattern. Though there are some similarities between the two structures, there are some significant distinctions.
We’ll get into the specifics of the diamond pattern structure later, but for now, keep in mind that the diamond pattern is a more complex chart pattern with reversal qualities. The diamond pattern is most common after a long period of trending. Nonetheless, technical traders should learn this pattern as it might present a familiar trading opportunity if detected early.
In the example above, we can observe the diamond top configuration. Keep an eye out for the diamond structure. The market rallies then retrace lower. The market then sets a higher high. Then the prices fall below the previous swing low, forming a new swing low.
Prices then rise higher again, forming the structure’s top. The price action then moves lower but not below the prior swing low. Prices rise again but settle below their earlier peak. Price falls again but stays above the previous swing low.
After this price action, we may draw four trend lines of similar size connecting the swing highs and lows of the structure. This creates a diamond shape, hence the pattern’s name. Occasionally, we may not notice every price leg within the diamond structure. This does not invalidate the structure’s designation as a diamond pattern. Most importantly, we can plot four trend lines of identical length around the structure.
What is a Bearish Diamond Pattern?
The bearish diamond pattern, often known as a diamond top, was previously described. Again, the pattern is a sequence of price swings that resemble the head and shoulders structure. A trend line will be formed by connecting the left shoulder and head, and a second trend line will be formed by the head and the right shoulder. The trend lines for the upper section of the bearish diamond formation are now complete. Then we connect the swing lows within the troughs to form a V shape.
The bearish diamond pattern may be seen once more in the figure above. This diagram also shows the breakout entry signal for trading the structure, such as the pattern’s target level. The short entry signal would be triggered at the break and close below the sloping upward lower right-hand line. Some traders prefer to wait for a breakout below this line without a close. This is also a good entry point, but keep in mind that it will result in more false signals than waiting for the breakout and close situation.
A measured move strategy is used to calculate the structure’s price target. We want to quantify the peak to valley distance within the structure and project that distance downhill from the breakout point. This will indicate a level at which we can expect the breakout to fade or reverse. As such, it is a great take profit and trade exit level.
What is a Bullish Diamond Pattern?
The bullish diamond pattern is the inverse of the bearish diamond pattern. A bullish diamond pattern, also known as a diamond bottom, occurs during a decline. A price move lower is followed by a consolidation phase that carves out the diamond bottom’s swing points. In this situation, it will resemble an inverted head and shoulders. Similarly, we shall connect the structure’s peaks and troughs. We can confirm the structure as a bullish diamond pattern once we have drawn the four trend lines around it.
As shown in the above diamond bottom image, the formation is followed by a price decline. The diamond structure’s up-down sequence is defined by the two upper trend lines pointing downward and two lower trend lines pointing upward. Break and close above the upper right-hand sloping line triggers the long entry signal.
Again, waiting for a breakout and close rather than merely a breakout above this trend line is better to avoid false signals and potential whipsawing price activity. The upper price objective is calculated by comparing the high and low inside the structure. Once determined and plotted on the chart, the same distance from the breakout point is projected upward to reach the selected goal level. Exit the entire position or a significant portion of it once the price reaches this level.
Trading Strategy with Diamond Patterns
Let’s now concentrate on developing a trading strategy that includes the diamond pattern. We’ve seen that the diamond technical pattern can occur in both an uptrend and a downtrend. When a strong price move precedes a diamond pattern, it is called a diamond top, and it has a bearish interpretation. A diamond bottom occurs when a bearish price move precedes the diamond pattern and has a bullish interpretation.
This diamond trading strategy will only employ price action; we realize that the diamond pattern is not common in the market. As a result, we don’t want to include too many variables in the strategy, which would filter out an otherwise good setup.
The rules for trading the diamond top chart pattern are as follows:
* There must be a visible upswing before the diamond top formation.
* The diamond top formation should be easy to identify with four trend lines that connect and are very close in length.
* When the pattern breaks, put a sell order at the market and close below the upward sloping trend line at the end.
* Set the stop-loss at the swing high that precedes the breakout point.
* The target level will be determined using a measured motion computation. The distance between the structure’s highest and lowest low will be calculated and projected downward from the breakout point. The profit exit point will be at this predetermined level.
* After 50 candles, if the price has not triggered either our stop-loss or target level, we will immediately exit the trade at the market.
The rules for trading the diamond bottom chart pattern are as follows:
* A clear downtrend is required before the diamond bottom may occur.
* The diamond bottom formation should be close to identifying with four closely spaced trend lines.
* Place a buy order in the market on a break and close above the downward sloping trend line.
* The stop-loss should be set at the swing low before the breakout point.
* The target level will be determined using a measured motion computation. The distance between the structure’s highest and lowest low will be calculated and projected upward from the breakout point. The profit exit point will be at this predetermined level.
* On the trade, there will be an additional time stop component. If the price does not trigger the stop-loss or target level after 50 candles, we will instantly exit the trade at the market.