Diamond Pattern
Firstly, a diamond pattern is a special shape on a chart. This shape looks like a diamond, hence the name.
The diamond pattern starts forming when there’s a lot of trading. The prices move within a broad range at first. Over time, this range starts to shrink. The shrinking range forms the first half of the diamond.
As the diamond forms, prices hit higher highs and lower lows. Then, things start to change. The prices reach the tip of the diamond. From here, the trend reverses. The trading range starts to widen again. This forms the second half of the diamond.
When does a trader know that a diamond pattern is confirmed? It’s when the price breaks out of the diamond shape. This break out happens in the opposite direction of the initial trend. This breakout usually comes with a high volume of trades.
What is the significance of a diamond pattern? Traders use it to predict where the price might go next. To do this, they look at the height of the diamond. The height is the difference between the highest and lowest prices in the diamond. They use this height to guess a target price.
Diamond Pattern in a Real Life Example
Let’s imagine you’re looking at the EUR/USD Forex chart, and you notice a particular shape forming.
At first, you observe that the EUR/USD has been trading within a wide price range. You note this is with high trading volume, which is an important detail.
As time passes, you see this range starts to narrow. It creates a form that begins to look like the left side of a diamond. This is the first indication of a diamond pattern potentially forming.
The price action hits higher highs and lower lows within this range. After a while, the pattern reaches its narrowest point. This is the “tip” of the diamond.
Then something interesting happens. The trend that had been narrowing starts to reverse. The price range begins to expand again, creating the right side of the diamond.
The moment of truth arrives when the price breaks out of the diamond shape. It moves in the opposite direction of the initial trend. This happens with a high trading volume. This breakout confirms the diamond pattern.
Now, you can use the height of the diamond to predict the price target. If the highest price within the diamond was 1.2000 and the lowest was 1.1800, the height is 0.0200. If the breakout was downwards, you might set a target price of 1.1600 (1.1800 – 0.0200).
Top 5 Reasons why traders use the Diamond Pattern in Forex trading
- Trend Reversal Indicator: The diamond pattern often appears at the end of long trends, signaling a potential trend reversal. This means if the price has been going up, it might start going down, and vice versa. It provides traders with an early warning, allowing them to adjust their trading strategies accordingly.
- Price Targeting: With the diamond pattern, traders can set an estimated price target. They measure the height of the diamond (the difference between the highest high and lowest low within the pattern), then project this distance from the point of the breakout. This helps in planning the trade, setting profit targets and understanding the potential reward of the trade.
- Risk Management: The diamond pattern can also assist with risk management. When the pattern is confirmed by a breakout, traders often set a stop loss just above or below the breakout point (depending on the direction of the breakout). If the price goes back into the diamond, the pattern could be invalid, triggering the stop loss and limiting potential losses.
- Versatility: The diamond pattern is versatile because it can appear in both uptrends and downtrends. Whether you’re in a bearish market (prices falling) or a bullish market (prices rising), you can use this pattern to predict potential trend reversals. This makes the diamond pattern a valuable tool in a trader’s toolkit, applicable in multiple market scenarios.
- Volume Confirmation: Usually, the formation of the diamond pattern comes with high trading volumes. High volume at the breakout point can serve as further confirmation of the pattern’s validity. A strong volume surge on the breakout can give traders additional confidence in the potential for a profitable trade.
However, as with all trading patterns, it’s important to remember that the diamond pattern should be used alongside other technical analysis tools. This helps to increase the likelihood of successful trades and reduce the risk of losses.
