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Diamonds Up

06/10/05 08:21:07 AM
by David Penn

A diamond continuation pattern leads the way higher in this medical equipment provider.

Security:   USPI
Position:   N/A

I first spotted this diamond continuation pattern back when it was just a diamond consolidation. Specifically, the date was May 18, and USPI's diamond pattern had just been completed. All that was necessary was the break--to the upside or downside.

Many times, the direction of breakouts can be anticipated. I've written about a number of these instances in Advantage, and many of these "anticipations" were courtesy of stochastic divergences.

Figure 1: After surviving a bearish scare--courtesy of a negative stochastic divergence--shares of USPI moved on to complete a diamond pattern over the next few weeks.
Graphic provided by: Prophet Financial, Inc.
This was not the case with this diamond consolidation, which, perched upon the support of the 10- and 50-day exponential moving averages (EMAs), did not feature the sort of, for example, positive stochastic divergence that would have anticipated the potential for an upside break.

In fact, if stochastic divergences had been hinting at anything, it might have been weakness. Note how the April high in USPI is higher than the March high. However, the 7,10 stochastic was higher in late March than it was in mid-April. This was actually a negative divergence and appears to have anticipated the late April correction, a correction that clipped two points off of USPI in a day.

The correction, nevertheless, did not turn out to be a reversal. Instead, prices climbed back above the 50-day EMA as the right side of the diamond pattern began to take form. At this point, while the bearishness of the recent negative stochastic divergence was no doubt still present, bears were required to give the benefit of the doubt to a stock that had taken the negative stochastic divergence smackdown and lived to tell the tale--on the bull's side of the 50-day EMA.

The fortunate thing about the diamond consolidation is that it helps the bears mark a point beyond which they could feel comfortable about the downside risks. Just because USPI avoided one negative stochastic divergence meltdown didn't mean that it couldn't succumb to another. And a close beyond the lower right-hand side of the diamond consolidation would have provided ample opportunity for USPI to do just that.

On the flip side, of course, a close beyond the upper right-hand side of the diamond pattern would signify the opportunity for a real breakout--which is precisely what occurred on May 23 on increasing volume (note the downward volume trend leading to the breakout).

With a formation size between five and seven points (depending on whether the extended tails or shadows on April 19 and 28 are included) and a breakout at about 46, the diamond continuation suggested an upside to anywhere between 51 and 53, which, interestingly enough, is where USPI shareholders find themselves right now.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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Date: 06/11/05Rank: 3Comment: 

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