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Tips to Use a Diamond Chart Pattern in Forex Trading

Most beginner Forex traders rarely use a diamond chart pattern. What’s more, some of them mistakenly think it is similar to a head-and-shoulders formation because of its V-shaped neckline. However, the two patterns are different.

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When it comes to a diamond formation, it expresses reversals that usually take place at major tops featuring higher volumes. In simpler words, reversals rarely take place at the market bottom. At the same time, we should say that a diamond chart pattern is a variation of the head-and-shoulders formation. So, they do have some common features.

In this article, we will discuss how to identify a diamond formation, how to trade it, and how it differs from the head-and-shoulders pattern.

A Diamond Pattern Explained

It refers to the reversal type of formations. The indicator shows the end of either a bearish or bullish trend. Most of all, you can find it at the top of the uptrend and rarely at the bottom, when the market is bearish.

As a result, we can use two different types of diamond formation:

  1. A bullish pattern.
  2. A bearish pattern.

Forex traders try to identify the diamond top and bottom to find potential opportunities to enter the market with a trade. Each type of pattern suggests either buying or selling opportunities.

How to Identify a Diamond Chart Pattern

It is quite simple to identify the formation on Forex charts. It is a diamond-shaped pattern that appears the same way as the head-and-shoulders pattern.

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To utilize it with your Forex strategies, you need to consider the following process:

  1. Identify the market conditions (a prevailing downward or upward trend).
  2. Plot a pattern using sideways price action as the period to start from.
  3. Connect periodic highs and lows with two trend lines.
  4. Identify a market entry for the bullish or bearish trade.

Now, let’s have a closer look at each type of diamond formation.

A Bullish Diamond Chart Pattern

Generally, it appears after a powerful downward price move. It is plotted with two resistance and two support levels. Resistance levels constrain the previous retracement while support levels constrain the downward move.

Forex traders usually call it a diamond bottom pattern. It provides them with potential buying opportunities. Sometimes, it is a signal for a bullish breakout.

A Bearish Diamond Chart Pattern

The formation appears after a strong upward price move. It contains two support and two resistance levels. Support levels constrain the previous retracement while resistance levels confirm the bullish trend.

It is also known as the diamond top pattern among Forex traders. It provides them with a selling opportunity.

How to Trade a Diamond Chart Pattern in Forex

Although the pattern is rarely used, it is quite easy to trade. The only thing you need to do is to determine the market entry, properly place your stop-loss, and set a viable profit target. The rest of the process including the order execution looks quite streamlined.

1. Determine the Market Entry

To determine whether it is a buying or selling opportunity, one would view the diamond formation at the top of the uptrend or at the bottom of the downtrend:

  • You should sell beneath the diamond top pattern.
  • You should buy above the diamond bottom pattern.

A formation helps traders decide whether to take a short or long position.

2. Place a Stop-Loss Order

To place a stop loss, you need to find a zone below the lower or above the upper extreme of the diamond formation. Simply follow these steps:

  • Place a stop-loss above the pattern.
  • Place a stop-loss below the pattern.

It is hard to identify the exact location for the stop loss, as it may vary.

3. Set a Profit Target

Setting a target profit is very easy. As a rule, the process is narrowed down to aiming for profit targets that are equal to the cart pattern height. However, some experienced traders prefer applying a static risk vs. reward ratio instead.

Diamond Formation Vs. Head-And-Shoulders Pattern

As stated earlier, a diamond formation is a variation of the head-and-shoulders pattern. They look similar on Forex charts.

On the other hand, the head-and-shoulders pattern generally occurs local to the upper quadrants of the bullish trend while a diamond formation can appear either at the market bottom or top. Both refer to a bearish type of indicators and both provide traders with long or short market entry opportunities.

Pros and Cons of Trading with Diamond Patterns

Like any other technical indicator, this one comes with certain advantages and downsides. The list below will help you decide whether to use it or not depending on the Forex strategies you generally apply.

Pros:

  • It occurs in any Forex pair despite the time frames.
  • Provides traders with buy and sell market entries.
  • Suits the reversal Forex trading strategy.

Cons:

  • Beginners may find it complex to construct.
  • Does not work efficiently on shorter time frames.
  • Can deliver false signals.

The Bottom Line

A diamond chart pattern can be a good tool to bring your Forex trading to a new level. It refers to the bearish type of indicators and comes as a variation of the head-and-shoulders formation. The main advantage of using diamond patterns is their ability to deliver buying and selling market entries.

At the same time. It can occur on the market tops and bottoms. Although it may be hard to construct, the pattern comes with a simple and straightforward trading technique that will suit even beginners. Just make sure to properly set stop-loss orders and place a profit target accordingly.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.