Bearish Diamond Pattern

Studying stock fundamentals gives important insight into their intrinsic value, but that’s not the only way to make trading decisions. Technical traders use various charting methods to illustrate how an asset’s price moves over time. 

Though market behavior is ultimately unpredictable, there is an elegant order to it. Historical patterns often repeat, and certain price movement sequences suggest future trends. While not infallible, the patterns and movement sequences are reliable enough for experienced technical traders to generate substantial returns under the right circumstances. 

Understanding how to read chart patterns and the significance of various sequences is the foundation of technical trading strategy. For the sake of simplicity, the industry has developed a vocabulary to reference common patterns. Examples include pennants, flags, head-and-shoulders, rectangles, and diamonds. 

The bearish diamond pattern, sometimes referred to as a diamond top, is a pricing sequence that occurs less often than pennants, flags, and similar. Because it is comparatively rare, many traders fail to recognize it. That’s unfortunate because the bearish diamond pattern is a strong indicator that shortfalls and retracements are coming, and those who can identify it quickly have an opportunity to make profitable trades. 

What Is A Diamond Pattern?

As the name suggests, a diamond pattern is one that – when lines are drawn in – takes the shape of a four-sided diamond. The easiest way to spot one begins with an off-center head-and-shoulders pattern. Specifically, the “head” is set closer to the left of the formation, while the tail is set closer to the right of the formation. 

Note: A traditional head-and-shoulders pattern is formed when pricing charts show three peaks. The two on the left and right are roughly the same height, and the center peak is higher than the “shoulders.” 

Once the appropriate pattern has been identified, create trendlines for the peaks and troughs. The first are the resistance trendlines, which connect the left “shoulder” to the “head” and then the “head” to the right “shoulder.”

Next, add the support trendlines. Connect the bottom of the lower trough to the left “shoulder” with one line, then connect the bottom of the lower trough to the right “shoulder” with a second line. 

If it is a true diamond pattern, when the four lines connect, the resulting figure is a four-sided diamond. 

Is A Diamond Top Bearish?

A diamond top pattern is also referred to as a bearish diamond pattern because it signals a change in the direction of a price trend.

Upward trends are marked by increasingly higher peaks and valleys – the left shoulder and head of a “head-and-shoulders” formation. The diamond top or head marks the maximum price a particular asset can achieve, and the subsequent peak or right shoulder marks a trend reversal. 

In other words, when a diamond top occurs, prices are changing direction. It is the start of a downtrend or a bearish trend.

Bearish diamond patterns are relatively rare, but when they are spotted in time, they tend to be reliable indicators of future price movement. That’s a win for technical traders who know what to look for and how to take advantage of this particular set of circumstances. 

What Is a Diamond Bottom Pattern?

A diamond bottom pattern is the inverse of a diamond top. Instead of showing the reversal of an uptrend, it occurs when a downtrend ends, and prices begin to increase.

Like the diamond top pattern or bearish diamond pattern, identification begins with detecting a head-and-shoulders pattern. However, instead of a traditional head-and-shoulders pattern, this one is inverted or upside down. 

The diamond shape is formed by adding and connecting the same four trendlines. When they are fairly even, the four-sided diamond shape appears, indicating a true diamond bottom or bullish diamond pattern.

Under these circumstances, a pricing trend is in the process of reversing. Traders can be fairly certain that an uptrend will follow.

Is a Diamond Pattern Bullish or Bearish?

Diamond patterns can be bullish or bearish, depending on the trend that precedes the pattern. When prices are trending up, and they hit a ceiling, a diamond top pattern occurs. This is a bearish diamond pattern that indicates prices are going to begin a decline. 

On the other hand, when prices are trending down, and they hit their floor, the diamond bottom pattern or bearish diamond pattern occurs. This pattern indicates that prices are trending in a positive direction. 

There are opportunities to generate returns in either case, but accurate identification of the pattern is critical to success. As mentioned, true diamond patterns are uncommon, and it is easy to mistake them for head-and-shoulders or inverse head-and-shoulders patterns. This is problematic because they require different strategies for optimal returns. 

The best moment to act on a head-and-shoulders pattern is when prices move below the “neckline” or support level after the right shoulder peak. In the case of an inverse head-and-shoulders pattern, the right moment to act is when prices move above the neckline or resistance level after the right shoulder trough. 

In the case of a diamond pattern, the neckline is V-shaped. While the moment to act is still related to a break in that neckline, it occurs sooner in a diamond pattern than a head-and-shoulders pattern. 

What Is a Diamond Continuation Pattern?

Any continuation pattern, including a diamond continuation pattern, is a suggestion that an asset’s price will continue its progress in the same direction once the pattern has been completed. However, continuation patterns do not consistently lead to a continuation of the trend. In many cases, the trend reverses. 

This inconsistency creates complexity for traders, as the direction is not immediately evident. Generally speaking, the best strategy is to wait for a breakout, at which point it is possible to make comparatively accurate trend predictions

Most traders choose to trade continuation patterns by trading in the direction of the breakout. In a best-case scenario, the direction of the breakout is also the trend direction. 

Diamond Pattern Candlesticks

Stock price charts are created using very specific figures that indicate the direction and level of change. More importantly, these figures offer insight into the emotion driving price changes – a key indicator of future price movements. 

The figures are referred to as “candlesticks” based on their resemblance to the body and wick of tapers. They offer a visual representation of four price points during the relevant period: open, close, high, and low. 

The body of the candlestick figure, referred to as the “real body” by traders, shows the range of pricing between the open and close of trading for the given day. When the close is lower than the open, the real body is filled in. When the close is higher than the open, the real body is left empty. 

Often, charts are designed to color candles red when prices decrease and green when they increase, but that can change based on the trader’s preference and the features of the charting platform. 

There is a “wick” on both ends of the candlestick figure. The top wick indicates the intraday high, and the bottom wick indicates the intraday low.

Short wicks show that the open or closing prices were close to the intraday high or low, while long wicks show that prices moved substantially higher or lower during the day before settling on a closing figure. 

The bearish diamond pattern is formed when candlesticks are charted over time. The resulting diamond pattern candlesticks can then be identified by attentive traders – ideally in time to execute an effective strategy that generates returns. 

How Do You Trade a Diamond Pattern?

Trading a bearish diamond pattern or a diamond top pattern can be profitable, but it is critical to identify the pattern correctly, then trade in the right direction at the optimal time. These are the basics for successfully trading a bearish diamond pattern: 

  • Ensure that there is an obvious uptrend in place before the formation of the diamond top. 
  • Confirm that a true diamond top formation has occurred by connecting the four trendlines. Each line should be similar in length in a diamond top pattern. 
  • Submit a sell order at market price when a break and close occurs below the upward sloping trendline to the right of the pattern. 
  • Place a stop loss at the price of the swing high that occurred just before the breakout. 
  • Calculate the profit exit point by measuring between the highest point and the lowest point within the pattern, then projecting that down from the breakout point. 
  • Select a reasonable time stop on the trade. If the price has not hit the target level or the stop loss level, exit the trade at market price when the allocated time has elapsed. 

Trading the bullish diamond pattern or diamond bottom pattern is the inverse of trading the bearish diamond pattern, as follows:

  • Ensure that there is an obvious downtrend in place before the formation of the diamond bottom.  
  • Confirm that a true diamond bottom formation has occurred by connecting the four trendlines. Each line should be similar in length in a diamond bottom pattern. 
  • Submit a buy order at market price when a break and close occurs above the downward sloping trendline to the right of the pattern. 
  • Place a stop loss at the price of the swing low that occurred just before the breakout. 
  • Calculate the profit exit point by measuring between the highest point and the lowest point within the pattern, then projecting that up from the breakout point. 
  • Select a reasonable time stop on the trade. If the price has not hit the target level or the stop loss level, exit the trade at market price when the allocated time has elapsed. 

While returns are never guaranteed, this strategy is effective in generating profits when executed properly. 

Pitfalls of the Diamond Pattern

There are no guarantees when it comes to trading, no matter how sound a particular strategy is. That’s why experienced traders confirm their predictions using additional data. The diamond pattern is no different, which is its biggest pitfall. The best way to mitigate risk is through a price oscillator. 

At their most basic, price oscillators provide insight into momentum. They are created by choosing an upper and lower value, then reading the trend that results from oscillations within those boundaries. 

When the oscillator values move towards the upper boundary, it can be an indication that an asset is overbought. When they move towards the lower boundary, it can be an indication that an asset is oversold. Oscillators can be combined with moving average indicators to develop predictions about trend reversals or trend breakouts. 

When trading a diamond pattern, the Moving Average Convergence Divergence (MACD) and the Relative Strength Index (RSI) are effective in confirming appropriate trades. Combined, this information gauges price action momentum, as well as a break in levels of support or resistance. 

How Often Does a Diamond Pattern Work?

It’s tempting to seek statistics that show how often a diamond pattern works – and that’s true of any trading strategy based on technical analysis. Unfortunately, that’s not possible when it comes to this sort of investing. The success of any strategy begins with accurate identification of the relevant pattern, and identification of a diamond pattern isn’t a simple task. 

Even when a diamond pattern is identified correctly, traders must make the right trade at the right time to profit. There are a variety of techniques available for confirming predictions and projections, but none are failsafe. As with any trade, waiting for certainty reduces the likelihood of making a profit since profits are positively correlated with the level of risk. 

The best that can be said is when traders identify diamond patterns early enough to execute effective strategies, these trades can be powerful, and there is room to achieve substantial returns. 

Diamond Pattern Crypto – Does It Work?

Both the bearish diamond pattern and the bullish diamond pattern are applicable to a wide variety of asset classes, though they are most commonly used for trading the forex or currency market. They work well in this asset category because currency is exceptionally liquid. That means price action moves smoothly, making it easier for traders to isolate the diamond pattern in time to act.  

With that said, the diamond pattern can be seen in crypto charts, and the use of similar diamond trading strategies offers an opportunity to generate returns.

Before venturing into crypto trading – especially from a technical perspective – become familiar with the special features of crypto markets. While many aspects of crypto trading are similar or identical to trading other assets, there are certain aspects that differ. Overlooking these distinctions can lead to unexpected losses.  

How To Trade a Diamond Pattern – The Bottom Line

Trading a diamond pattern, whether it is a bearish diamond pattern or a bullish diamond pattern, requires a certain amount of experience and expertise. This pattern isn’t easy to spot, and correct identification of the formation is critical to success. 

Diamond patterns can be found in all types of markets, but they are relatively rare. When they are accurately distinguished from other patterns that closely resemble the diamond, traders who use the right strategy at the right time may realize impressive returns. 

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