Among the number of chart patterns that traders use to try and predict stock movements, a rare but powerful pattern is the diamond pattern. As with all technical patterns, the shape indicates patterns in price movements, thereby revealing the psychology and sentiment of buyers and sellers.
As a trader, understanding the diamond pattern is a useful addition to your trading toolkit.
Here’s what it is.
The diamond chart pattern is so called because of its rhombus-like shape. It appears near the top or the bottom of the market, following a strong trend. Its appearance can signify that the trend is about to reverse.
A diamond chart pattern starts when the stock chart appears to broaden – this means the price is making successively higher tops and lower bottoms. That is the left side of the "diamond." As the price pattern continues to build, the price will now start trading within a tightening range, making lower highs and higher lows. This completes the diamond shape.
The symmetric configuration of the diamond pattern shows a non-committal market but one gearing up for a big move. Once it appears, traders can expect the price to break out of the diamond formation, reversing the prevailing trend.
The diamond chart pattern is among the many reversal technical patterns that could predict price movements. The pattern typically marks the end of long trends and warns a trader of the possible change of direction in the market.
It's a relatively rare formation, but when it occurs, it can result in highly rewarding trades, particularly if confirmed by other technical indicators. Normally, price action after a breakout from a diamond pattern is sharp, making a good entry point as well as an exit point.
To determine the breakout direction, one would have to interpret what the diamond chart pattern is describing. If the diamond pattern appears following an uptrend and the price breaks down, it may be a bearish reversal signal.
Conversely, a breakout on the upside following a downtrend indicates bullish reversal and a possible rise. Volume also plays a critical role in breakouts, and the existence of high volumes confirms the strength of the reversal. The pattern remains indecisive if no breakout has been confirmed.
The diamond chart pattern shows an increased period of indecision in the market, where both the buyers and sellers are struggling to dominate. The broadening price at first suggests extreme highs and lows, meaning neither side has an edge over the other. The price movement later tightens as the pattern continues, showing that the market is becoming focused and preparing to make a decisive move. The tightening of price action indicates that the market participants are waiting for a strong breakout and, once it happens, it could trigger a powerful reversal as one side finally gains control.