They begin with a big climb or drop in price, followed by a leveling out that’s also marked by contraction. The diamond occurs when the initial contraction begins to swing volatilely before contracting again, right before another big price swing. The problem is, traders can’t know whether the second price swing will be up or down until the break.
Diamond recognition trading revolves around investor psychology, as most patterns do. This pattern looks at a very specific way of thinking that factors into how the stock behaves.
After a large movement, investors are eager either to take profits ( ) or to short ( ). This causes the first round of consolidation. Then there’s a period of instability that occurs as investors become emboldened by the . The second round of consolidation is a pullback, which serves to restabilize the price. The final breakout occurs when investors seek to capitalize on the current level en masse. Essentially, diamonds signal uncertainty that traders can capitalize on.
Creating certainty during a time of instability can be very lucrative for day traders. Where some might choose to preempt a diamond and set their target price too soon, investors who weather the consolidation in the back half of a triangle are positioned to reap maximum returns.