Testing reversal formations in bond futures

Write the sketch as checks a series can fail

Editorial: chart-pattern evaluation starts when a sketch is rewritten as a sequence of checks that a single market series can pass or fail. This article follows that rules-first path for head-and-shoulders and for double-top and double-bottom formations.

The historical workflow first defined swings, then required an uptrend context, then applied symmetry filters, then treated a move through the neckline as a completion hypothesis, and only then attached an entry, a price objective, and a failure exit.

Start with reactionary highs and lows

A reactionary high is a local maximum more than 1 point, or 32 ticks, above the previous reactionary low. A reactionary low is a local minimum more than 32 ticks below the previous reactionary high.

Those two definitions create the swing series on which later pattern rules operate. Editorial: without a shared swing rule, two readers can disagree about whether the same chart even contains a formation.

Code the head-and-shoulders top after an uptrend

A head-and-shoulders top requires four consecutive reactionary highs. The last three of those highs serve as the left shoulder, the head, and the right shoulder, and the head must stand above both shoulders.

To place the formation after an uptrend, the left shoulder must stand above the prior reactionary high and the left armpit must stand above the previous reactionary low.

The neckline is the line connecting the left and right armpits. A close through that line is the event that can complete the pattern.

Filter lopsided formations with symmetry

Vertical symmetry requires each shoulder to sit above, and each armpit below, the midpoint of the opposite shoulder and armpit. The rule rejects formations that are lopsided in height.

Horizontal symmetry requires the number of days from the left shoulder to the head to be no more than 2.5 times and no less than 0.4 times the number of days from the head to the right shoulder.

Complete the top and state a price objective

After the right shoulder forms, a decline through the neckline completes the top only if that drop lasts no longer than the span between the shoulders and price does not rise above the head.

The stated price objective equals the height of the pattern projected from the breakout level. The bottom definition is the inverse of the top.

Attach one entry and two exits

The coded head-and-shoulders top enters short at the settlement on the first close below the neckline. It exits for a profit on the first close below the objective and books a loss on the first close above the right shoulder. The bottom rule is the inverse.

Editorial: those three prices turn the completed formation into a hypothesis that the same series can accept or reject. They are not a recommendation to trade the pattern.

Keep double tops and bottoms on the same experiment path

A double top or double bottom is a two-peak or two-trough reversal structure completed on breakout. The inverse definition is used for bottoms.

Editorial: keep the same experiment logic. Name the swings, require completion on breakout, and accept or reject the hypothesis on the same series. Do not treat a freehand double sketch as a result.

Test both reversal families on one continuous series

The test used a continuous Treasury bond futures series adjusted so that no price gap occurred on rollover. It traded one contract and charged no slippage or commission.

Across the 21-year Treasury bond sample the two reversal families produced 28 coded trades, of which 17 were winners, and the average winner was 1.41 times the size of the average loser.

Editorial: those counts describe the historical workflow on one frictionless series. They are not a forecast and they are not investment advice.