The diamond pattern is one of the rarest but most powerful chart formations in technical analysis. When you spot this pattern correctly, it often leads to significant price moves. In this comprehensive guide, we will teach you how to identify diamond patterns, understand the psychology behind them, and trade them profitably.
What is a Diamond Pattern?
A diamond pattern is a chart formation that resembles a four-sided diamond shape. It forms when price first expands outward (like a broadening formation) and then contracts inward (like a symmetrical triangle). The result is a pattern that looks like a diamond or rhombus on the chart. This pattern is classified as a reversal pattern, meaning it typically signals a change in the prevailing trend.
Key insight: The diamond pattern represents a shift in market psychology. The initial expansion shows growing uncertainty, while the subsequent contraction shows that one side (buyers or sellers) is gaining control and volatility is decreasing before a decisive move.
Types of Diamond Patterns
Diamond Top (Bearish)
A diamond top forms at the peak of an uptrend and signals a potential reversal to the downside. It is the more common of the two diamond patterns. The pattern shows that buyers are losing momentum and sellers are starting to take control.
Diamond Bottom (Bullish)
A diamond bottom forms at the end of a downtrend and signals a potential reversal to the upside. This pattern is rarer than the diamond top but can lead to powerful rallies. It shows that sellers are exhausted and buyers are stepping in.
How to Identify a Diamond Pattern
Recognizing a diamond pattern requires careful observation:
The Four Trendlines
A complete diamond pattern has four trendlines:
- Upper left line: Connects the ascending highs during the broadening phase
- Lower left line: Connects the descending lows during the broadening phase
- Upper right line: Connects the descending highs during the contracting phase
- Lower right line: Connects the ascending lows during the contracting phase
Pattern Characteristics
- Must have at least two touches on each trendline
- The pattern typically takes 1-3 months to form on daily charts
- Volume usually declines as the pattern develops
- The pattern should be preceded by a clear trend
Diamond Top Example
Stock XYZ rallies from $40 to $60 over two months, then forms a diamond:
- Broadening phase: Highs at $61, $63; Lows at $57, $54
- Contracting phase: Highs at $62, $60; Lows at $55, $56
- Pattern width at widest point: $9 ($63 - $54)
- Breakdown occurs below $56 on high volume
- Entry: $55.50 (short position after breakdown)
- Stop loss: $60 (above pattern)
- Target: $47 ($56 - $9 pattern height)
Volume Analysis
Volume provides crucial confirmation for diamond patterns:
- During formation: Volume typically expands during the broadening phase and contracts during the tightening phase
- At breakout: Volume should expand significantly when price breaks out of the pattern
- Volume divergence: Declining volume during the pattern suggests the trend is losing momentum
Entry Strategies
Breakout Entry
The most common approach is to enter when price breaks out of the pattern:
- Wait for price to close outside the diamond boundary
- Confirm breakout with above-average volume
- Enter on the same candle or wait for one candle confirmation
- Set stop loss inside the pattern
Retest Entry
A more conservative approach waits for a pullback:
- Wait for the initial breakout
- Wait for price to pull back and test the broken trendline
- Enter when price resumes in the breakout direction
- This provides better risk-reward but you may miss some trades
Calculating Price Targets
The measured move technique works well for diamond patterns:
- Measure the height of the pattern at its widest point
- For a diamond top: Subtract the height from the breakdown point
- For a diamond bottom: Add the height to the breakout point
- This gives you the minimum expected price target
Stop Loss Placement
Proper stop placement is critical for diamond trades:
- For shorts (diamond top): Place stop above the highest point of the pattern
- For longs (diamond bottom): Place stop below the lowest point of the pattern
- Alternative: Place stop just inside the opposite trendline after breakout
False Breakouts
Diamond patterns can produce false signals. Here is how to avoid them:
- Wait for confirmation: A close outside the pattern, not just an intraday pierce
- Check volume: True breakouts have expanding volume
- Timeframe matters: Patterns on daily and weekly charts are more reliable
- Context is key: Consider the broader market trend
Diamond Pattern vs Similar Patterns
Do not confuse the diamond with these similar formations:
Head and Shoulders
The diamond is more symmetrical and has four trendlines rather than the distinct three peaks of a head and shoulders pattern.
Symmetrical Triangle
A symmetrical triangle only contracts from the start. The diamond first expands then contracts.
Broadening Formation
A broadening formation only expands. The diamond has both an expansion and contraction phase.
Tips for Trading Diamonds
- Be patient: Diamond patterns are rare. Do not force the pattern where it does not exist
- Use multiple timeframes: Confirm the pattern on a higher timeframe
- Check for prior trend: Reversal patterns need a trend to reverse
- Combine with other analysis: Use support, resistance, and indicators for confirmation
- Size appropriately: Due to rarity, do not overtrade when you finally spot one
Track Your Diamond Pattern Trades
Pro Trader Dashboard helps you log your chart pattern trades, track success rates, and improve your pattern recognition over time.
Real-World Considerations
Keep these practical points in mind:
- Pattern quality varies: Not all diamonds are perfectly shaped. Some asymmetry is acceptable
- Time to form: Patterns that form too quickly or too slowly may be less reliable
- Market conditions: Diamond patterns work better in normal volatility environments
- News events: Fundamental catalysts can override technical patterns
Summary
The diamond pattern is a rare but reliable reversal formation that consists of an initial broadening phase followed by a contracting phase. Diamond tops appear at market peaks and signal bearish reversals, while diamond bottoms appear at market troughs and signal bullish reversals. Success with this pattern requires proper identification with four trendlines, volume confirmation on the breakout, and disciplined risk management with stops placed beyond the pattern extremes. Calculate your price target by measuring the pattern height and projecting from the breakout point.
Expand your pattern recognition skills with our guides on reading stock charts and technical analysis fundamentals.