Packaging two-bar reversals into testable entry and exit rules

A pattern is not yet a procedure

Candlestick patterns in this write-up are two-session OHLC structures that share a higher high and a lower close, then split on whether the prior low is pierced and whether the close finishes below that low.

Editorial: a two-bar reversal is only a research object after it is locked to an n-day extreme filter, a next-open rule-based entry, a hard initial stop, and a high/low trailing stop that does not wait for a mirror-image candle.

Three reversal definitions and the extreme filter

Three related two-session reversal definitions share a higher high than the prior bar and a close below the prior close, and they differ only on whether the prior low is pierced and whether the close finishes below that low.

The n-day extreme filter is a gate that counts a reversal only when that bar is also the highest high or lowest low of the most recent n sessions. A reversal counted as a signal only when it passed that gate. Other prints were ignored.

Rule-based entry and the first stop

Rule-based entry is a next-session open after a reversal that also marks an n-day extreme, with non-extreme prints ignored and an inverse rule for longs. After a qualifying reversal, the entry was the next session's open, and an initial stop was placed one point beyond that reversal day's high or low.

The trailing stop is a high/low lookback used first as a one-point protective stop beyond the reversal extreme and later as the liquidation level when no opposite reversal is assumed.

Liquidation without a mirror candle

Because an opposite reversal was not assumed to appear, open trades were liquidated with a simple high/low trailing stop rather than by waiting for a mirror pattern.

One fully specified short used a 30-day new high plus a reversal, sold the following open, placed a protective stop one point above the high of the day before entry, and liquidated at the most recent 10-day high. Longs inverted those rules.

Nested models and a position reverse

Nested pattern models are three entry gates that accept any of the three reversal variants, only the two stricter variants, or only a close below the prior low. Those three nested entry models were compared: one fired on any of the three pattern variants, one on the two stricter variants, and one only when the close finished below the prior low.

A position reverse is flipping an open short to a long when a bullish reversal prints, instead of leaving the short untouched until the trailing stop is hit. A bullish reversal printed while a short was open reversed the position instead of leaving it untouched.

What a closed procedure can still miss

The tests scanned setup lookbacks from 5 to 40 days and trailing-stop lookbacks from 5 to 30 days, applied a $100 per-trade cost assumption, and used five years of perpetual series.

Several reversal days can print during a multi-month trend before a final extreme, so the procedure can take losses on the way and can miss a major move if no pattern appears at the actual turn.

Editorial: those failure modes are the classroom point. Tightening the candlestick definition changes which prints pass the nested gates, but it does not remove the need for the extreme filter, the next-open entry, or the trailing stop.