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Introducing The Bearish Diamond Formation

 

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For years, market aficionados and forex traders alike have been using simple price patterns not only to forecast profitable trading opportunities but also to explain simple market dynamics. As a result, common formations such as pennantsflags and double bottoms and tops are often used in the currency markets, as well as many other trading markets.

In this article, we'll explain how forex traders can quickly identify diamond tops in order to capitalize on various opportunities. The diamond top occurs mostly at the top of considerable uptrends. It effectively signals impending shortfalls and retracements with relative accuracy and ease. Because of the increased liquidity of the currency market, this formation can be easier to identify in the currency market than in its equity-based counterpart, forex background, where gaps in price action frequently occur, displacing some of the requirements needed to recognize the diamond top, forex background.

This formation can also be applied to any time frame, especially daily and hourly charts, as the wide swings often seen forex background the currency markets will offer traders plenty of opportunities to trade. The diamond top formation is established by first isolating an off-center head-and-shoulders formation and applying trendlines dependent on the subsequent peaks and troughs.

It gets its name from the fact that the pattern bears a striking resemblance to a four-sided diamond. First, we identify an off-center head-and-shoulders formation in a currency pair. Next, we draw resistance trendlines, first from the left shoulder to the head line A and then from the head to forex background right shoulder line B.

This forms the top of the formation; as a result, the price action should not break above the upper trendline resistance formed by the forex background shoulder, forex background. The idea is that the price action consolidates before the impending shortfalland any penetrations above the trendline would ultimately make the pattern ineffective, as it would mean that a new peak has been created. As a result, the trader would be forced to consider either reapplying the trendline line B that runs from the head to the right shoulder, or disregarding the diamond top formation altogether, since the pattern has been broken.

To establish lower trendline supportthe technician will simply eye the lowest trough established in the formation, forex background. Bottomside support can then be drawn by connecting the bottom tail to the left shoulder line C and then connecting another support trendline from the tail to the right shoulder line D.

This connects the bottom half to the top and completes the pattern. Notice how the forex background angle of the formation also resembles the apex of a symmetrical triangle pattern and is suggestive of a breakout.

Trading the forex background top isn't much harder than trading other formations. Here, the trader is simply looking for a break of the lower support line, suggesting increasing momentum for a probable shortfall. Forex background theory is quite simple. Both upper resistance and lower support levels established by the right shoulder will contain the price action as each subsequent session's range diminishes, suggestive of a near-term breakout. Once a session closes below the support level, this indicates that selling momentum will continue because sellers have finally pushed the close below this significant mark.

This approach works forex background well in the currency markets, forex background, where price action tends to be more fluid and trends are established more quickly once certain significant support or resistance levels are broken, forex background. Money management would be applied to this position through a stop-loss placed slightly above the previously broken support level to minimize any losses that might occur if forex background break is false and a temporary retracement takes place.

Figure 2 below shows a zoomed-in view of Figure 1. We can see that a session candle closed below or "broke" the support trendline line D. The diamond top trader would profit from this by placing an entry order below the close of the support line at forex background. The standard stop will be placed 50 pips higher at 0, forex background.

In our example, the stop order would not have been executed because the price failed to bounce back; falling instead, pips lower in one session before falling even further later on, forex background. Notice how the position of the entry is just below the support line D. Finally, forex background, profit targets are calculated by taking the width of the formation from the head of the formation the highest price to the bottom of the tail the lowest price, forex background.

The bottom of the diamond top is exactly 0. This leaves pips between the two prices that we use to form the maximum price where we can take forex background. To be safe, the trader will set two targets in which to take profits, forex background.

The first target will require taking the full amount, forex background, pips, and taking half that amount and subtracting it from forex background entry price. Then, the first target will be 0, forex background.

The price target that will maximize our profits will be 0. One of the cardinal rules of successful trading is to always receive confirmation, and the diamond top pattern is no different. Adding a price oscillator such as moving average convergence divergence and the relative strength index can increase the accuracy of your trade since tools like these can gauge price action momentum and be used to confirm the break of support or resistance.

Applying the stochastic oscillator to our example Figure 4 belowthe investor confirms the break below support through the downward cross that occurs in the price oscillator point X, forex background.

Figure 4 - The cross of the stochastic momentum indicator point X is used to confirm the downward move. Although the formation occurs less in the cross-currency pairs, forex background, the swings tend to last longer, creating more profits. This chart shows all the trendlines, the highest and the lowest price, forex background, and the price target.

Although the bearish diamond top has been overlooked due to its infrequency, it remains very effective in displaying potential opportunities in the forex market. Smoother price action due to the enormous liquidity of the market offers traders a better context in which to apply this method and isolate better opportunities.

Technical Analysis Basic Education. Your Money. Personal Finance. Your Practice. Popular Courses. Login Newsletters. Trading Strategies Beginner Trading Strategies. Identify the head and shoulders pattern and confirm the offset nature of the formation by noticing that the head is set slightly to the left, forex background, while the tail is set to the right. Form the top resistance by connecting the left shoulder to the tip-top of the head line A and the head to the right shoulder line B.

Next, draw the trendlines for support by connecting the left shoulder line C to the tail forex background the tail to the right shoulder line D. Calculate the width of the formation by taking the prices at the top of the head, This will give us a total of pips of distance before we can take our full profits.

Divide by two and our first point to take profits will be pips below our entry. Establish the entry point. Look to the apex of the right shoulder and notice the point where the candle closes below the support line, breaking through.

Here, the close of the session is The entry order should then be placed 50 pips below at Calculate the first take profit price by subtracting pips from the entry. As a result, forex background first profit target will be at Finally, confirm the trade by using a price oscillator.

Here, the stochastic oscillator signals ahead and confirms the opportunity as forex background breaks below overbought levels point X.

Compare Investment Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Articles. Partner Links. Related Terms Diamond Top Formation Definition A diamond top formation is a technical analysis pattern that often occurs at, or near, market tops and can signal a reversal of an uptrend. Neckline Definition A neckline is a level of support or resistance found on a forex background and shoulders pattern that is used by traders to determine strategic areas to place orders.

Currency Pairs Definition Currency pairs are two currencies with exchange rates coupled for trading in the foreign exchange FX market. Triple Bottom A triple bottom is a bullish chart pattern used in technical analysis that is characterized by three equal lows followed by a breakout above resistance. How Triple Tops Warn You a Stock's Going to Drop A triple top is a technical chart pattern that signals an asset is no longer rallying, and that lower prices are on the way.

Major Pairs Definition and List Major pairs are the most traded foreign exchange currency pairs.


 

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