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How to Trade Diamond Chart Patterns
2022-04-26 • Updated
Information is not investment advice
As a real treasure, the true Diamond chart is extremely rare on the market. To use its signals, you need to wait until the model is completely formed on the chart, and to identify such a figure correctly and timely in the medium term.
What is Diamond Chart pattern?
The diamond formation is a classic chart pattern. However, it doesn’t appear as often as flags, head and shoulders, and rectangle patterns. There aren’t many opportunities to trade the diamond chart pattern. However, technical traders should become familiar with this it as it provides a good trading opportunity if recognized early enough.
The diamond pattern most often occurs after an extended trend phase. When it happens during a bull market, the pattern is referred to as a diamond top or bearish diamond pattern. That’s because the price reverses down after such diamond. Conversely, when a diamond occurs in the context of a bear market, the pattern is referred to as a diamond bottom or bullish diamond pattern due to its bullish meaning.
The reason for the rarity of the diamond chart pattern lies in the fact that it takes quite a long time to form. First, it should form the support and resistance lines, diverging almost at strong angles to the horizontal lines, and then converge again in one structure. The result is a diamond shape. That’s how it got its name.
On the chart below you can see a diamond chart pattern which occurred on February 8, 2022, at the GBPUSD chart.
In reality, the patterns are not as neat and even as in the diagrams. The main thing is to respect the logic of both highs and lows and an approximate form.
Bearish Diamond Pattern
A variation of the bearish diamond, also known as the diamond top, was described in the previous section. Traders can view the pattern as a series of up and down price swings that resemble a head and shoulders pattern structure.
Specifically, the left shoulder and the head will join to form a trend line, while the head and the right shoulder will form a second trend line. It completes the trend lines for the top of the bearish diamond formation. Then, for the bottom part, we'll connect the swing lows inside the troughs, which will form a V-shape.
Referring to the illustration above, we see the bearish diamond pattern again. In this chart, we can see a breakout entry signal for trading the diamond structure along with a target level for the pattern. Besides, the short entry signal will provoke a breakout and close below the lower right line slanting upward.
Some traders prefer to wait only for a break below this line without requirement for a close below it. This is also a possible entry point, however, be aware that it will result in more false signals than waiting for a breakout and a close condition.
The target price for the structure is calculated using the measured movement method. Specifically, we want to measure the distance from a peak to a trough within a structure and then project that distance down from the breakout point. It will provide a level where we can expect the continuation of the breakout to begin to wane or possibly reverse. Thus, it represents an excellent Take Profit and exit level.
Bullish Diamond Pattern
Let's now look at the opposite of the bearish diamond, which is a bullish diamond. A bullish diamond pattern, also called a diamond bottom, occurs after a downtrend. We usually see a substantial price move down and then a consolidation phase that carves up and down swing points on a diamond bottom.
In this case, the appearance will be similar to an inverted head and shoulders pattern. We will connect the peaks and troughs within the structure in the same way as described earlier. Once we draw four trend lines around the structure and confirm that the four lines are roughly equivalent in size, we can confirm the structure as a bullish diamond pattern.
Looking at the diamond bottom illustration above, we see that a downward price move precedes the formation. There’s an ascending sequence in a diamond structure, which is outlined by two upper trend lines pointing down and two lower trend lines pointing up.
A break and close above the upper right line with a downward slope triggered the signal to enter a long position. Again, the preferred method would be to wait for an actual breakout and close rather than just a breakout above this trendline to prevent false signals and potential price movement around this area.
It’s reasonable to calculate the upper price target by measuring the high and the low inside the closed structure. Once we calculate this distance and plot it on the chart, we’ll extend the same distance from the upward projected breakout point to reach our preferred target level. Once the price reaches this level, we should consider closing the entire position, or at least a large part of it, and possibly leaving a smaller part open if necessary.
Diamond Pattern Trading Strategy
Let's now turn our attention to creating a trading strategy that includes a diamond pattern. We’ve seen that the technical formation of a diamond occurs both in the context of an uptrend and a downtrend. When a bullish price action precedes a diamond pattern, it is called a diamond top and has bearish overtones. When a diamond pattern precedes a bearish price move, it is called a diamond bottom, which has a bullish connotation.
We’ll try to keep it as simple as possible using a pure price action approach in this diamond trading strategy. We’re aware that the diamond pattern isn’t widespread in the market. Thus, we don't want to add too many variables to the strategy that could filter out an otherwise good setup.
Here are the rules for trading the diamond top chart pattern:
- A clear uptrend must be in place before the diamond top formation.
- The diamond top formation should be clearly defined with four trendlines that connect to each other, and which are relatively close in length to one another.
- Enter a sell order at the market upon a break and close below the upward sloping trendline near the completion of the pattern.
- It’s preferable to place the Stop Loss at the most recent swing high preceding the breakout point.
- The target level will be calculated based on the measured movement calculation. We’ll measure the distance between the highest high and the lowest low within the structure and project it down from the breakout point. This forecast level will act as an exit point.
- The trade will have an additional time stop component. Specifically, if after passing 50 candles, the price hasn’t worked either on our Stop Loss or the target level, we immediately exit the trade on the market.
The trading rules for the diamond bottom chart pattern are vice versa:
- There must be a clear downtrend before a diamond bottom forms.
- The formation of a diamond bottom should be clearly defined by four trend lines that connect with each other and are relatively close in length to each other.
- Enter a buy order in the market after the breakout and close above the downtrend line near the pattern's completion.
- It’s preferable to place the Stop Loss at the most recent swing low before the breakout point.
- The target level will be calculated based on the measured movement calculation. We’ll measure the distance between the highest high and the lowest low within the structure and project it upwards from the breakout point. This forecast level will act as an exit point.
- The trade will have an additional time stop component. Specifically, if after passing 50 candles, the price doesn’t work on either the Stop Loss or the target level, we’ll immediately exit the trade on the market.
Diamond reversal patterns are seen in all different types of financial markets, including the stock market, Forex market, cryptocurrency market, and futures markets. The diamond pattern is not as common as many other classic chart patterns. However, it’s important that you understand the pattern and be able to recognize it, because when it occurs, it can provide a trading opportunity.
A diamond top that occurs after a rise in market prices generally provides a higher probability of a trade than a diamond bottom pattern that occurs after a decline in market prices. You’ll need to do your own testing to see if this trend matches the markets you are trading.
Financial markets alternate between periods of decline and growth. They are related not only to the economy, but also to the psychology of investors.
Inflation doesn't come from nowhere. There’s always a reason for it to occur. Moreover, it’s often happening because of human mistakes and biases.