Wednesday, April 27, 2011

Is this a ‘diamond pattern’ which I see before me?

With apologies to the late great William S. for paraphrasing a quote from Macbeth’s soliloquy, it does look like the Nifty 50 index formed a rare ‘diamond pattern’, which is usually a reversal pattern. It can some times be a continuation pattern also.

What are the conditions that are needed to satisfy a diamond reversal pattern? Like all reversal patterns, it should have something to reverse – in other words, it should form at a market top after a prolonged up move. In the case of the Nifty 50 index, this condition has been satisfied.

Like the name, the pattern must be visually diamond-shaped – a initial broadening formation that transforms into a converging symmetrical triangle. A look at the weekly Nifty 50 bar chart confirms this second condition.

Why a weekly chart? The diamond pattern is more clearly defined and easier to spot on a weekly chart. (I did take a look at Nifty’s long-term weekly chart recently, but the pattern wasn’t visible in the closing chart pattern.)

Nifty_Diamond top_Apr2711

A clearly discernible diamond pattern has been marked on the Nifty 50 chart above. British comic writer Douglas Adams said: “If it looks like a duck and quacks like a duck, we have at least to consider the possibility that we have a small aquatic bird of the family anatidae on our hands.”

We also have to consider the possibility that we have a diamond of the bearish reversal pattern family on our hands. Another condition – that of depleting volumes during the pattern formation – has not really been satisfied. Is there a possibility that this particular diamond may end up shining brightly for the bulls and prove to be a consolidation pattern that was designed to trap the bears? Nothing can be ruled out on chart patterns. (No wonder investors get confused by technical analysis!)

Was the diamond indeed a reversal pattern, in spite of the comparatively higher volumes during its formation? Like the head-and-shoulders reversal pattern, the diamond has measuring implications. The index is expected to fall at least by the same amount (from the break down point) as the difference between the peak and trough of the diamond.

In our case, the high of the week ending Nov 5 ‘10 was 6338 (diamond peak) and the low of the week ending Nov 26 ‘10 was 5690 (diamond trough) giving a difference of 648 points. Interestingly, the break down point from the diamond pattern occurred at 5900 – a support/resistance level. (Now you know why the Nifty is struggling to cross 5900!)

How far did the Nifty fall? 722 points to the low of 5178 in the week ending Feb 11 ‘11 – thereby more than meeting the minimum down side target of 648 points. Does that mean that the Nifty reversal is over and done with? It would appear so from the subsequent pattern formation.

Would readers like to take a shot at analysing the pattern(s) that formed since the break down from the diamond? The technical indicators are suggesting bullish pattern(s) with measuring implications.

There will be no brickbats thrown for incorrect responses, so no need to feel shy about attempting an answer! Logical answers with upside targets will be duly acknowledged. Note that diamond patterns, which are quite rare, hardly ever form at bottoms of chart patterns.

3 comments:

Titu said...

Hello Sir,
22100 may be the next target, why? because it is a 127.2% fibonacci level of the down trend from 21000 to 17728, but I think before that we will see a time wise correction

it's just a wild guess....

-titu

Subhankar said...

Reader Suresh wrote the following comment on Apr 29 '11, but a technical glitch in Blogger didn't allow him to post it:

"Subhankarji

With whatever little knowledge I have, I think the weekly Nifty chart seems to indicate a 'Cup and Handle' formation since the breakdown from the Diamond pattern. If so, the handle formation could take Nifty down to 5685 or 5575 level.

Suresh"

Subhankar said...

@Titu: You may be right, but you didn't answer the question about the pattern after the breakout from the diamond.

@Suresh: Good observation; your downside target has been met. But the Nifty has fallen below 5550 (which is the mid-point of the 'cup') and has formed a bearish rounding-top.

Looks like the 'cup and handle' has been negated, and the Nifty can drop to 5300.