The diamond pattern is one of the most popular formations in trading.
It is a very strong indicator, which can be used to trade both the long and short positions.
This pattern is not only useful in forex but also in:
- Commodities,
- Stocks,
- Indices,
- Cryptocurrencies
In this article, we will take a look at the bullish and bearish Diamond patterns.
We will also discuss the most important rules of using this formation and give you some tips on how to execute it.
Let’s jump in:
What Is Diamond Pattern Trading?
Diamond pattern trading is where a trader will use a specific chart setup, that is shaped like a diamond (shock!), to indicate a potential reversal opportunity in the near future.
These setups are quite rare, but they are powerful.
They are named after the diamond shape formed when the lines connecting the price highs and lows form a diamond shape.
A head-and-shoulders is created by looking for a head, shoulder and two troughs (or valleys) that occur around the middle of the chart.
However, these types of head and shoulder setups are not as symmetrical as you’d expect, thus giving the diamond chart setup.
So even if you see a head and shoulders formation develop – you can still use this analysis to potentially spot a diamond setup.
This opportunity is often seen in conjunction with other chart setups, such as an inverse head and shoulders formation.
It can also be seen in conjunction with other indicators, such as the stochastic oscillator.
The setup can be found in both the long and short-term charts, which can be a reason why it is so popular.
When it comes to diamond chart trading, it serves as a powerful reversal tool as we will find out later on with the stats that back it up.
Are Diamond Chart Patterns Bullish or Bearish?
The short answer is that there are no rules, no one way of reading a chart and no certain setup will predict the future.
But that doesn’t mean we can’t use some rules of thumb to make better decisions and to help us avoid major losses.
For example, we can look at a diamond chart pattern and ask ourselves whether it’s bullish or bearish.
To make things confusing, the answer is it can be BOTH.
However, it depends on the price direction and where the diamond formation has appeared.
Let’s breakdown the pattern:
Bearish Diamond Top Pattern
Diamond top patterns are when the chart appears at the top of an upward trend.
These setups more commonly indicate a potential reversal.
However, it is not uncommon for the trend to continue IF the price breakouts to the upside of the price action.
Here is an example:
Bullish Diamond Bottom Pattern
Diamond bottom patterns are when the setup appears at the bottom of a trend.
These are more commonly indicate a potential reversal to the upside.
With that being said, it is not rare for the trend to continue IF the price breakouts to the downside of the formation.
Now let’s find out what these formations mean.
Here is an example of the setup:
What Do Diamond Top Patterns Mean?
Before you learn how to trade them, you have to understand what these setups mean and what drives them to appear.
This will help you understand the underlying reason why the market moves in order to obtain a clearer analysis.
A diamond top formation can be mistaken for a head and shoulders pattern due to the similarity of their shapes.
When a diamond top formation develops:
the underlying reason is that sellers have entered the currency in an aggressive way.
So much so that they are able to pull back a upward move swiftly, and create new lower lows.
Which gives a similar approach to what looks like a slanted head and shoulders pattern.
You can apply the opposite logic when you have identified a bearish diamond top formation.
Thus prepared for a short position, and I’ll show you how to do that shortly.
According to Tom Bulkowski mentioned here:
The Diamond Top Pattern breakouts to the downside 54% of the time.
This gives this an edge when looking for a selling opportunity.
What Do Bullish Diamond Bottom Patterns Mean?
Now you know what it means when a diamond is discovered at the top of a trend, but what about the bottom of a downtrend?
It’s easy.
It’s just the opposite action, this time it’s the buyers taking control.
The opposite to the diamond top formation is the diamond bottom pattern.
This is where the market consolidates towards the bottom of its longer-term downtrend and the buyers look to take over.
Thus creating new highs that break the market structure.
Sometimes, an inverse head and shoulders pattern may form first.
This is a good leading indicator prior to the diamond chart completion, but I’ll share that bit later on.
Once you have identified the bullish diamond chart at the end of the downtrend, you can prepare an order to enter long.
Based on Tom Bulkowski’s backtesting on the diamond bottom pattern:
This setup breakouts to the upside 74% of the time, which gives an excellent edge when looking for a reversal.
Now you know the theory and what they look like, it’s time to learn how to find these patterns & profit from them.
How to Trade A Bearish Diamond Top Formation
Let’s take a look at how to trade a bearish diamond top pattern, step by step.
Step 1: Identify the Diamond Top Formation
You can identify a diamond top pattern by the following criteria:
- Top of a move that has consolidated
- 2x Higher highs match the following 2x lower highs
- 2x higher lows match the following 2x lower lows
I know that sounds a bit complicated, but it’s not once you see it visually:
As you can see, after drawing the trend lines you can depict the pattern.
Step 2: Plot the Breakout Move
The great thing about chart patterns is that it’s possible to predict the breakout movement by measuring the chart formation.
We can do this by means the distance between the low of the pattern and the high of the pattern like so:
As you can see this gives us a potential breakout range of 34 pips to the downside. This is usual information for when we want to target a take profit level.
Step 3: Wait For a Breakout Confirmation
You should wait until the price penetrates and breakout from the diamond chart before entering the position.
In this step, it is ideal to set an alert at the breakout area (pictured below) so you can be alerted to the recent price action.
Don’t fear missing out on the “perfect” trade entry.
You should always wait for the price action to close before concluding your technical analysis!
Step 4: Enter The Trade Diamond Chart
Now the price has closed below the breakout level we wanted it’s time to set up the trade.
The optimal entry-level I have found is when the market trades lower than the breakout candlestick’s low.
With the order level set, add the stop loss level at either of the following levels:
- 50% of the chart setup’s range (the middle point); or
- The high of the chart formation
Either works, but depends on your tolerance to risk.
Then finally, add the take profit level (if you wish to).
The take profit level for this set-up is the range we measured in Step 2.
Add your orders to your pending order and wait until the market executes you.
Or if the market is already trading below the breakout candlestick’s low, then enter at the market order – or wait for a slight pullback to the same level.
Your entry should be looking like this:
The Results
As you can see that the trade broke out from the pattern and traded lower hitting our predicted take profit level.
Now let’s look at the bullish version!
How to Trade A Bullish Diamond Bottom Pattern
If you grasped the concept of the bearish set-up, you’ll understand its diamond pattern bullish version just as easily.
Step 1: Identify the Diamond Bottom Formation
You can identify a diamond top pattern by the following criteria:
- Bottom of a bearish move that has consolidated
- 2x Lower lows matching the following 2x higher lows
- 2x higher highs that match the following 2x lower highs
This is what you should look out for visually:
By using the trend line tool, we can draw this out and easily see the symmetry that confirms the diamond bottom pattern.
You just have to connect the highs and the lows.
Step 2: Plot the Breakout Move
We find this range by measuring the distance between the high of the pattern and the low of the pattern like so:
This shows us a potential breakout range of 21 pips to the upside.
This is the measurement we need so we can set a realistic take profit level.
Step 3: Wait For a Breakout Confirmation
Now you just wait until the breakout is confirmed before entering the trade.
This is achieved by the breakout candlestick (AKA the trigger).
Again, set an alert for this level so your attention is drawn to it once the price penetrates this level.
As you can see, the alert level is set in the image below:
Step 4: Enter The Bullish Trade Diamond
With the breakout candlestick confirming the move, it’s time to enter the trade by setting up an order level.
With the order level set, add the stop loss level at either of the following levels:
- 50% of the diamond chart pattern’s range; or
- The low of the diamond chart pattern
Depending on your risk level, either work.
Lastly, add the take profit level.
Go back to Step 2 and grab the pattern’s range and use that to give you a potential take profit level.
Your order placement should be like so:
The Results:
With the analysis in place and breakout confirmed, the market hit the order level and executed the trade.
Continued the move higher and hit the take profit level netting 21 pips.
Not bad eh?
Conclusion: Diamond Pattern Trading
In conclusion, the diamond pattern trading process is the same.
Whether it’s a bearish or bullish pattern.
The main difference is the range and take profit levels.
The key to this is knowing how to measure the chart pattern’s range.
By setting up the right level, you can profit from a breakout from a diamond chart pattern.
If you are interested in becoming a successful trader:
It is important that you understand what it takes to be successful and to achieve the level of skills necessary to succeed.
Happy hunting!