Stock trading is often referred to as a gamble. But the fact is that a lot of science backs the activity. Several technical aspects of stock trading can help you understand when to enter or exit the market. If you develop an interest in the various technical charts and patterns of analysis, you will be able to predict what to expect out of your investment. One of the most commonly used technical analysis chart during share market investments is the diamond top chart pattern. Here’s an introductory guide to help you understand the diamond top pattern.
Diamond top formation definition
A type of technical analysis pattern, diamond top formation is a pattern which typically occurs at or near to market tops. The formation essentially signals that an uptrend may be reversing. This formation is so named due to the presence of the trend lines that connect the troughs and peaks, and are carved out by a stock’s price action to form a ‘diamond’ shape.
Breaking down the diamond top formation
Although they are generally uncommon, when they form, diamond top formations can be reliable indicators for an imminent reversal of a current uptrend. The pattern begins to form or occur when strong, up-trending prices begin to flatten sideways, over an extended period, marking the formation of a diamond shape. These imminent, potential reversals provide technical traders with the opportunity to book sizeable profits, which is why they are always looking for such reversals. Its ability to offer sizeable returns makes the diamond top formation a substantially potent pattern. As per analysts, a potential move can be planned by calculating the highest point and lowest point in a diamond formation when the neckline of the diamond formation is broken and then added to the breakout point.
Diamond top and diamond bottom pattern trading – occurrence and misidentification
Diamond top formations ideally only occur when an uptrend ends or is near its end, whereas diamond bottom pattern trading formation occurs when a downtrend ends. The top formation is often confused with the head and shoulders formation, which is regarded as much more powerful. If you are a new, inexperienced trader, you should be aware of the difference between the diamond top pattern and the head and shoulders reversal pattern, since the former occurs just before the latter. If you misidentify the two, you could be shorting the market prematurely. Also, note that the diamond patterns may also be compared to double tops and bottoms; however, the latter has less distinctive lows and highs.
Characteristics of diamond top formations
Now that we know what is a diamond top formation and when it occurs let us look at its primary features and understand when it forms. Here are the characteristics of diamond tops
1. The price of security should be trending upward
2. The price action should begin to resemble a broadening pattern, where, at the onset, the peaks are much higher while the troughs are significantly lower
3. Next, the price action changes again albeit in the opposite direction, i.e. when the peaks are much lower while the troughs are higher
4. Once connected, the peaks and troughs will come together to form the shape of a diamond, which is typically tilted to one side.
Although it occurs rarely, the diamond pattern is quite reliable. While trading in stocks, bearish or diamond top chart patterns are more common than bullish or diamond bottom chart patterns. Reach out to Angel One advisors to know more about the diamond top and bottom formations and how to recognise them while trading.