Introduction
A diamond chart (or diamond top) formation is a bearish chart pattern which occurs rarely at the top of considerable uptrends. It is a variation of a head-to-shoulders pattern, so investors commonly mistake every heads and shoulders as a diamond formation. The diamond top signals an impending fall, and can be applied to any time frame (i.e. daily, hourly).
Application
Start by identifying a head-and-shoulders pattern in a currency pair.
Then, we draw resistance lines by linking the left top (or shoulder) to the middle top (the head), and then the head to the right shoulder. Resistance lines are trendlines which ‘resists’ upward price movement due to a higher supply of said currency at that price level.
Next, we draw support lines by connecting the two bottom tails to each shoulder. Support lines are trendlines which keeps a currency above a certain level due to an increase in demand at that price level.
After constructing a four-sided diamond, we expect a break of the lower support line. Since the right half of the diamond represents a pennant shape (suggesting decreasing trading volume of the currency), it can be used as an indicator for an impeding breakout. Once the support line is broken by a downtrend, it may be a good opportunity to short the currency. As shown in the graph above, the price drops quite drastically following a breakout from the diamond.
Notes
The diamond top can be used in conjunction with a price oscillator, to confirm profitable opportunities.
The technique works better when the head-and-shoulders formation is off center.
It is common to set a price target, equal to the height of the diamond from its upper and lower vertex. For instance, if the top of the diamond is 800 pips higher than the bottom of the diamond, then an investor should approach a trade with an 800-pip price target.