What is Diamond Top Formation?
A Diamond Top Formation is a technical pattern that often occurs at or close to the top or peak of the market position. This type of pattern is occasional and does not occur as regularly as other technical patterns such as the bearish engulfing candlestick pattern or the shooting star candlestick pattern.
The diamond top formation signals a reversal in the uptrend that has been occurring in the market and hence is also sometimes referred to as “a bearish diamond pattern”. It is so named due to the diamond-like form the pattern takes on. The diamond top formation is essentially a broadening pattern which is then followed by a triangle, the first half of the pattern consists of an upwards sloping resistance line and a downward sloping support line which leads us to the peak and trough which connect the top and the bottom of the diamond. The second part of the diamond then follows with a downward sloping line of resistance and an upward sloping line of support.
Accurately predicting and acting upon the forthcoming reversals forecasted by the diamond top formation provide technical traders with the opportunity to book sizable profits in the long term as well as capitalise on a short sell position. It is important to remember that this pattern occurs when strong, up-trending prices begin to flatten sideways over a prolonged or extended period which then marks the shape of a diamond. This may even occur over years at a time, hence reading and predicting this rare technical pattern takes greater experience and skill as compared to many other forms of technical charts and patterns.
Diamond top patterns are rather uncommon yet reliable and are often an excellent source of detecting reversals. Due to their prolonged nature and rarity in occurrence, they are often used along with other technical indicators and patterns to maximise the odds of success.
Characteristics of diamond top formation
Diamond top formations have a few easily noticeable or salient features which allow them to be easily identifiable by technical traders. These include:
An upward trending price movement:
For a diamond top formation to occur, the price of the security must be trending upwards. Conversely, for a diamond bottom formation to occur, the price should trend downwards then leading to a diamond formation.
Broadening price action
At the outset, the peaks must be significantly higher and the troughs, lower with the gaps widening until the highest and lowest points of the diamond are achieved. The price action then changes the opposite direction where the peaks become much lower and the troughs much higher.
Along with the prolonged up and down-trending, you can identify a few other patterns and trends which help in determining the diamond top formation. The diamond pattern itself may be identified by connecting the peaks and troughs. A diamond shape is formed and is usually tilted to one side. It begins with a breakout gap and is followed by several runaway gaps as the price follows its trend.
How do we identify a diamond bottom?
A diamond bottom pattern is again a form of technical analysis which predicts a bullish reversal in security prices. Just like the diamond top formation, a diamond bottom pattern can be slightly messy and may require a few other technical patterns and tools for accurate representation and identification.
A diamond bottom formation occurs after a prolonged downward trend. You may see a diamond forming with a change in the line of resistance from downwards to upwards until it reaches the diamond peak or highest market price within the diamond. Then, there is another reversal in the line of resistance to downwards and a change in the line of support to upwards, which is finally followed by a shift in the general security price trend from downwards to upwards.
Diamond patterns are relatively uncommon or rare, yet they make an effective market predictor and can be used alongside other technical analysis tools to maximise the opportunity of success. Diamond top patterns (bearish patterns) are more common in comparison to diamond bottom patterns (bullish patterns). To learn more about technical and fundamental analysis tools and how to use them in your trading journey, reach out to IIFLs team of experts today!
Frequently Asked Questions Expand All
A diamond pattern as a whole indicates a forthcoming change in market direction whereas the diamond top formation indicates a change in market trends from upwards to downwards (bearish change) and a diamond bottom formation indicates a change in market trends from downwards to upwards (bullish change).
It is crucial that when trading with a diamond formation you apply the use of a stop-loss. A Stop loss must be placed above the last top inside the diamond for a bearish position and below the last low inside the diamond for a bullish set-up to guarantee profit protection.
The nature of a diamond pattern depends on when and where it is occurring. A diamond top pattern is bearish as it occurs after a prolonged upward trend and indicates a market reversal downwards, whereas a diamond bottom pattern is bullish as it occurs after a continuous downward trend and indicates a shift in trend upwards.