What is the Diamond Top and Bottom Pattern?

IntermediateOct 19, 2023
The diamond top and bottom patterns are powerful reversal patterns. Although rare, the diamond patterns can provide significant rewards when learned well.
What is the Diamond Top and Bottom Pattern?

The diamond top and bottom chart patterns are classic reversal patterns used in technical analysis to predict the market’s trend and end. The diamond chart pattern is rarely seen on charts, unlike patterns like flags, pennants, and heads and shoulders, which are more common. The diamond top pattern is a bearish reversal pattern, while the diamond bottom pattern is a bullish reversal pattern, providing powerful signals.

This article will explore the diamond chart patterns and how they are formed. It will also provide practical tips for using them effectively.

The Diamond Top and Bottom Pattern Explained

The diamond chart pattern is formed when the troughs, peaks, support, and resistance lines (or highs and lows) of an asset connect, forming the shape of a diamond. The pattern occurs when the market’s trend faces exhaustion, followed by a period of consolidation (when the pattern is formed), and transitions into a new trend (when the breakout happens).

The diamond chart pattern is often confused with the head and shoulders and the Quasimodo pattern because they all look similar and are reversal patterns but have a few key differences in price structure.

On the one hand, the head-and-shoulder pattern has a baseline or neckline with three peaks, while the Quasimodo pattern also has three defined peaks of highs and lows. On the other hand, diamond patterns can have several peaks and troughs. Also, the highs and lows do not have a defined neckline. Instead, trendlines connect the peaks and troughs, and traders must wait for the price to break out of the structure before confirming a trend change.

Characteristics of the Diamond Top Patterns

The diamond top pattern is a bearish reversal pattern that forms at the exhaustion of a bullish trend. It forms near market tops after the market has made a series of higher highs and higher lows and trending.

The Diamond Top Pattern

The left shoulder (the highs) begins the consolidation phase and is joined to the head with a trendline (points A to B). The head is then joined to the left shoulder to form another trendline (points B to C), forming the pattern’s upper part, which looks somewhat like an inverted V shape. The bottom part of the pattern is formed by connecting the swing lows to form a V shape (points A, D, and C).

The structure of the diamond top pattern begins from point A, which rallies to a high and retraces lower to point D. The asset rallies to point B, breaking the first high. From point B, the price retraces lower but fails to break the low at point D. It rallies up again but also fails to break the high at point B. Points B to D are usually the longest part of the structure and are often used to measure profit targets. At this stage, there is a high tendency for the price to break out as the diamond top pattern is already completed.

Points A, B, and C form the upper part of the diamond top pattern, while points A, D, and C form the lower part of the pattern. When trendlines connect all these points, they form a diamond shape, hence where the pattern draws its name from.

To identify if a diamond top pattern has been formed, traders should look for the pattern after the market has been bullish and trending, not ranging.

Source: Tradingview

The chart shows a diamond top formation at the consolidation phase after a bullish trend. When the price breaks out of the diamond top, it reverses and turns bearish.

Characteristics of the Diamond Bottom Patterns

The diamond bottom pattern is a bullish reversal pattern that forms when a bearish trend is about to end. It forms near market bottoms after the asset has made consecutive lower lows.

The trendline connects the lows of the left shoulder to the head, which forms the bottom of the pattern (points A, B, and C), forming a V shape. The upper part of the pattern connects the highs (points A, D, and C), forming an inverted V shape.

Diamond bottom pattern

The diamond structure begins from point A; the price drops low to point B, creating a low before retracing to point D. The price drops low to point B once again but fails to break the low before retracing to point C, ready for breakout.

Points A, B, and C form the bottom of the diamond pattern, while points A, D, and C form the upper part. The diamond bottom pattern is accurately spotted after an asset has been in a bearish trend.

Source: Tradingview

After the diamond bottom formation and breakout after a bearish trend, the price reversed and started a bullish trend.

Trading Strategies Using the Diamond Top and Bottom Patterns

Recognizing Potential Reversals

The diamond patterns can be used to spot potential trend reversals. For example, in the 4H chart below, MANA/USDT had been bullish, creating the diamond top pattern, and the price dropped after.

Source: Tradingview

The chart shows that MANA/USDT reversed into a bearish trend after forming a diamond top pattern after a bullish price.

Entry and Exit Points

To get better trade signals, professional traders combine the diamond patterns with other technical momentum indicators and strategies such as the Relative Strength Index (which can indicate overbought or oversold market conditions), breakout and retest, and candle close.

Source: Tradingview

The chart shows an entry strategy combining the diamond top pattern with the breakout and retest strategy. After the price has broken out of the diamond pattern, traders can enter after the retest. Traders can close long trade positions after spotting a diamond top pattern on the chart.

Some aggressive traders prefer to enter immediately after the breakout, while others wait for a candle close after the breakout before taking a trade. Conservative traders prefer to wait for a retest of the breakout, as shown in the chart above, before taking an entry to avoid false breakouts.

Risk management

No trading strategy generates 100% accurate signals. Traders have the responsibility of managing risk and preserving capital when trading. In some scenarios, the market may continue in its initial trend even after creating a diamond pattern.

Appropriate position sizing and placing protective stop loss orders will help to manage risk. Typically, the profit target for diamond patterns is the length of the most extended portion of the structure, as shown in the image below. Trades can be closed if the price fails to hit this target after 50 candle bars.

Source: Tradingview

Key Points to Remember When Using the Diamond Top and Bottom Patterns

  • A clear trend (bullish or bearish) must have been in place before forming the diamond pattern.
  • The pattern should be clearly defined and highlighted with four trendlines that connect the peaks and troughs.
  • Stop loss orders should be placed at the last swing high (for diamond tops) or low (for diamond bottoms) before the breakout.
  • The profit target is calculated based on the distance between the longest part of the pattern or the 50 bars timestamp rule (which states that trades should be closed after 50 candles if the price has not triggered TP or SL).

Pros of Using the Diamond Pattern in Trading

  • The diamond patterns can be used to generate both bullish and bearish signals.
  • They can be applied in any timeframe, and the validity of the signals generated is reliable regardless of the timeframe it occurs.
  • The diamond reversal patterns offer large profits.

Cons of Using the Diamond Pattern in Trading

  • The diamond patterns are rarely seen on the charts as they mostly only appear at the end of a trending market, presenting few trading opportunities.
  • Most patterns that rely on breakouts can produce false breakout signals, and the diamond pattern is no exception. Price may break the trendline, giving a false breakout, only to reverse into the pattern—traders who trade breakouts without waiting for a retest risk falling prey to false breakout signals.
  • Profit targets for diamond patterns are only sometimes precise. Although the set-up projects a recommended profit target, sometimes, the price may not get to the target before reversing even without even hitting the 50 bar time stop.

Conclusion

The diamond pattern is a powerful technical chart pattern traders can use to take reversal trades. Trading reversals are risky; hence, traders should use appropriate risk management techniques to preserve capital.

The diamond patterns occur rarely and are not easily spotted on the chart, making it difficult for traders to know how it looks to trade off them. However, with proper backtesting and practice, traders can master the pattern and spot them.

The pattern takes a while to form; patience is needed to avoid rushing into trades and getting trapped because of false breakouts. With enough practice and patience, the diamond patterns can be a very profitable trading chart pattern for traders.

Author: Bravo
Translator: Sonia
Reviewer(s): Matheus、KOWEI、Ashley He
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