Diamond formations are rare, but when they are spotted, they tend to be a strong indication of a reversal depending on their position in relation to the trend.  When they occur in the course of an uptrend, they typically hint at a reversal.

If you’re not familiar with the pattern, here’s a simple description:

 

  • Price establishes both a swing high and swing low within a few bars of each other (order varies as to which one happens first).
  • Instead of price breaking above the swing high or swing low, it begins consolidating to a point where the highs form a small downtrend and the lows form a small uptrend.

diamond1 A Rare Diamond (Formation) in the Homebuilders Industry

Sometimes prices do break trendline support and move downward. But don’t be surprised if price continues moving upward, as that too happens. In either case, how might you swing trade it? To answer that question, let’s take a look at Beazer Homes, or BZH.

 

We covered BZH a few weeks back when it exhibited a flag formation. Now it is exhibiting a diamond formation. 

diamond2-300x143 A Rare Diamond (Formation) in the Homebuilders Industry

August 2 marked the high point of the formation [1] at the price of 12.12, while August 5 marked the low point [2] at the price of 10.71. A standard way to trade this formation would be to take the height of the formation and adding that to the breakout of the trendline either up or down. 

 

So if we were to subtract 10.71 from 12.12, we would come up with 1.41. Since price already broke the downtrend line we would subtract take that price point (11.31) and subtract 1.41 from it which would give us a target price of 9.90 as shown at [3]. But IF the price were to break above the trendline, say, at 11.80, then we would add 1.41 to the price which would give us a target of 13.21 as shown at [4]. Right now, a swing trader would probably wait to see at [5] whether the break below the trendline can be confirmed as a legitimate break downward. 

 

But at any rate, that’s a traditional approach to trading a diamond formation. And BZH looks a bit bearish, but again, it’s a little early to tell. 

 

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