Diamond Top Formation

DEFINITION of 'Diamond Top Formation'

A diamond top formation is a technical analysis pattern that can be used to detect a reversal following an uptrend. This pattern occurs when a strong up trending price shows a flattening sideways movement over a prolonged period of time that forms a diamond shape.

BREAKING DOWN 'Diamond Top Formation'

Diamond top formations are generally uncommon however when they do form they can be a strong indicator for a reversal. Detecting reversals is one of the most profitable trading opportunities for technical traders therefore identifying a diamond top formation can be very useful. Diamond top formations will only occur at the end of an uptrend while their counterpart the diamond bottom forms at the end of a downtrend. Diamond tops and bottoms can also generally be comparable to double tops and bottoms however they tend to have less distinctive highs and lows.

Trends and Reversals

Technical analysts typically seek to identify defined trends and subsequent reversals as these patterns usually provide the most profitable trading signals. Up trending and down trending prices usually include some standard patterns that help to make trends more easily identifiable. Most up or down trends will begin with a breakout gap and be followed by several runaway gaps as the price follows its trend.

Traders will use a variety of different types of envelope channels that set upper and lower boundaries around a trend for the purpose of understanding the volatility ranges of a security’s price and its potential reversal points. Since security prices generally oscillate over time, channel boundaries can be a good tool for providing indication of the points at which a reversal may occur.

Diamond Top Reversal Signals

Diamond tops typically form at the end of an uptrend which makes them a powerful signal for a reversal. Usually, these patterns will look similar to an off-center head and shoulders pattern or a flattened double top pattern. Traders identifying a potential diamond top will seek to draw trendlines around the pattern which form a diamond shape. The pattern must continue trading within the trendline boundaries in order to be classified as a diamond top. If the price action remains within the boundaries, the trendlines can provide isolated resistance and support levels that can help a trader to trade into the reversal. (See also: Introducing the Bearish Diamond Formation)

Technical traders watch for patterns forming at a security price’s resistance trendline. Oftentimes, the resistance trendline will serve as a reversal point for the security’s price however it can also be common for the price to move through the resistance trendline and continue pushing higher. Diamond top reversal patterns are one of several trend reversal patterns that can help a trader determine a security’s price momentum at its resistance level. Generally, most technical traders will seek to identify strong technical patterns such as a diamond top reversal at a security’s resistance level before betting on the security’s price movement. If a diamond top reversal is detected, then a trader will likely sell or short sell to profit from a new downtrend formation.