When you begin trading, it is common to experience a form of overtrading, either to make profits, recover losses, or find the optimal entry and exit points. It can help to study rarer chart patterns such as the Diamond Bottom that sometimes offer well-defined entry and exit frameworks, though they are not guaranteed or always optimal.
In this article, we will discuss the Diamond Bottom Pattern, its structure, how to identify it, how to trade it with an example, its advantages, and its disadvantages.
What is the Diamond Bottom Pattern?
The Diamond Bottom Pattern is one of the rarest and powerful chart patterns, indicating a potential bullish reversal at the bottom of a downtrend after the price consolidation.
The term “Diamond” refers to the diamond-like shape that is formed, and the pattern can form over days, weeks, or even months, depending on the price action.
Once this consolidation of the price is over, the price typically breaks out to begin a strong bullish trend after the pattern is formed, and you can observe the increased volume on the buying side.
Structure of Diamond Bottom Chart Pattern
- Diverging and converging Trendlines: On the price chart, four trendlines are drawn, two diverging, followed by two converging in an ongoing downtrend.
- Left side: During the broadening phase, one line connects higher highs and another connects lower lows; during the narrowing phase, a line connects lower highs and another connects higher lows to form the right half of the diamond.
- Right side: It is drawn by connecting a series of lower lows, and another line is drawn by connecting the series of higher lows, which acts as a strong support line.
- Breakout candle: As the bullish candle closes above the resistance line of the pattern, it is an indication of the pattern’s breakout.
Together, the wide then narrowing range forms a diamond-like shape.
How to identify the Diamond Bottom Chart Pattern?
Start by identifying a security in a downtrend. Look for price swings that first widen, then contract, forming a diamond shape. Draw trendlines connecting them, which diverge toward a start point and converge to the end point, forming a symmetrical triangle and an inverted symmetrical triangle connecting in an ongoing downtrend.
As price consolidates, the trading volume tends to increase as the price swings widen, and the trading volume decreases as the price swings become shorter.
Wait for a breakout: The pattern is confirmed when the bullish candle closes above the resistance line, signalling a long-buying opportunity.
How to trade the Diamond Bottom chart pattern?
Buy signal:
Entry:
- Enter a long trade in the security when the price breaks and closes above the diamond bottom chart pattern formed.
Stop-loss:
- An ideal stop-loss is placed at the low of the most recent swing low within the Diamond Bottom pattern.
Target:
- Measure the height of the diamond and project it upward from the breakout point, and set the primary target.
Target = Breakout Point + (Height of the Diamond)
- Or, according to your trading strategy, place the target on a 1:1, 1:2, or higher risk-reward ratio.
Example:
The chart below shows an example of “ RIL Ltd” stock at a 30-minute timeframe from 9th to 14th May 2024, and you can see the buy signal generated by the Diamond Bottom Chart pattern.
What are the advantages of the Diamond Bottom Pattern?
- The Diamond Bottom Pattern is one of the highly reliable bullish reversal patterns in technical analysis.
- The trendline of the Diamond Bottom Pattern acts as a strong support after the breakout of the pattern.
- The Diamond Bottom Pattern provides a clear entry, stop-loss, and target for everyone.
- The Diamond Bottom Pattern is versatile across all timeframes and all other security markets, as a single strategy can be applicable for all markets.
What are the disadvantages of the Diamond Bottom Pattern?
- As volatility increases during the Diamond Bottom pattern formation, it can lead to frequent price swings and false signals, making it hard to trade for beginners.
- The Diamond Bottom Pattern often takes a long time to develop, especially on higher timeframes.
- When the price moves above the trendline with low volume, and then it quickly reverses, especially during a volatile market results in a false breakout of the Diamond Bottom Pattern.
In Closing
In this article, we learned the Diamond Bottom Pattern, its structure, how to identify it, how to trade it, along with an example, its advantages, and disadvantages.
The Diamond Bottom Pattern is a powerful tool used to identify potential bullish reversals in the ongoing downtrend after a consolidation, and it indicates multiple opportunities for clear entry and exit rules that are easy to follow.
Your profitability depends on your approach to the trade, your risk management, and your mindset when you are holding the trade, as no indicator or tool is 100% accurate, and when the Diamond Bottom Pattern is combined with additional indicators or tools (RSI, MACD, or others), its efficiency and accuracy increase rapidly.
