Module 3

The Rules

Module 3 of 6
Rule 1: Entry

Higher Highs

2+ consecutive higher highs on daily bars. Enter at next day's open. Longs only.

Fresh entries only. After an exit, wait for the state to reset (close below SMA(20)Simple Moving Average of the last 20 daily closing prices. Acts as a trend filter and trailing stop reference.) before taking a new signal.

No indicators. No confirmation. Just price.
Rule 2: Exit

Two-Phase Exit

Phase 1: When SMA(20)-3 is above your entry (common on dip-buy entries), place a disaster stop at entry minus 200 pts. This is black swan protection. It has never been hit in 6 years of data.

Phase 2: Once SMA(20)-3 drops below your entry, switch to the SMA trailing stop. From here, it only ratchets up. No profit target. No time exit.

~50% of entries start in Phase 1. All of them won. The disaster stop is insurance you'll hopefully never use.
Two rules, two phases. That's it.
85 trades. 8 years. Profit factor 1.99. Walk-forward: 3/3 periods. (post-audit, 2026-04-08)

When does the signal actually fire?

This is the most common mistake new traders make with this strategy. Read this carefully.

You see two green candles in a row after a selloff. Your instinct says: "The trend is back. I should buy at tomorrow's open."

That instinct is wrong. Here's why.

Green candles are not higher highs.

A green candle means the close was above the open. That tells you nothing about whether the high was above yesterday's high. A small green candle can have a lower high than yesterday. A red candle can have a higher high than yesterday. Colour does not matter. Only the highs matter.

Walk through it day by day.

FRIDAY SEP 6
Big red candle. Market drops 95 pts.
High: 5532
HH count: 0
No signal. No trade. Move on.
MONDAY SEP 9
Small green candle. Bounce.
High: 5493. Yesterday's high was 5532.
HH count: 0
Green candle, but the high (5493) is LOWER than yesterday (5532). Not a higher high. Count stays at zero.
TUESDAY SEP 10
Another small green candle.
High: 5506. Yesterday's high was 5493.
HH count: 1
5506 > 5493. That's higher high #1. One is not enough. We need two.

This is where new traders jump in.

You've seen a big red candle, then two green candles. It looks like a reversal. Your gut says buy. But you only have one higher high. The signal has not fired. If you enter here, you're guessing, not following the system.

WEDNESDAY SEP 11
Third green candle. Bigger body this time.
High: 5567. Yesterday's high was 5506.
HH count: 2
5567 > 5506. Higher high #2. Signal fires at today's close. You know this AFTER the bar is finished.
THURSDAY SEP 12
ENTRY at the open: 5562.75
TRADE ON
This trade ran for 28 days and made +262 pts ($1,310 on 1 MES).

The rule is simple but strict.

You cannot use today's high to make today's decision. Today's high is not known until the bar closes. So the signal fires at the close of the second higher-high day, and the entry is at the next day's open. You are always one bar behind. That is not a flaw. That is how you avoid lookahead bias.

What if I enter a day early?

If you enter after 1 higher high instead of 2, you are taking trades that haven't passed the signal threshold. In the data, requiring 2 consecutive higher highs filters out bounces that fail. Single higher highs happen all the time during selloffs. Most of them reverse the next day. The second higher high is the confirmation that momentum has actually shifted.

Entering early means more trades, more losers, and a lower profit factor. The patience to wait for the second HH is part of the edge.

What if I see two green candles but they don't have higher highs?

No trade. Green candles with lower highs mean the body is positive (close > open) but the range is dropping. The market is bouncing weakly. The highs are what matter because the high is the furthest price was willing to go. If that ceiling is falling, there is no trend to ride.

This is the most common misread. Two green candles after a selloff feel like a reversal. But if the highs aren't expanding, the sellers are still in control. Wait for the highs to confirm.

Trade Walkthrough: Winner

Trade 83: +262 pts ($1,310 on 1 MES) • Sep 12 - Oct 23, 2024 • 28 days
Step 1/6

Trade Walkthrough: Loser

Trade 40: -38 pts ($190 on 1 MES) • May 27 - Jun 9, 2022 • Bear market
Step 1/5

What happens after a stop-out?

You get stopped out. The trade is over. Now what?

The system doesn't sulk. It follows a simple re-entry sequence:

1
Stop hit. Trade closed. System enters "wait for reset" mode.
2
Reset. The higher-high streak must break. At least one day where today's high is NOT above yesterday's. The pullback that stopped you out almost always does this.
3
Fresh signal. Price recovers and makes 2 new consecutive higher highs. That's a fresh entry. Back in at next open.

This happens faster than you might expect. In the real data, the system re-entered within 1 to 3 trading days of a stop-out on multiple occasions:

Stopped outRe-enteredGapNext trade result
Sep 14, 2020Sep 161 day+11 pts
Sep 25, 2020Sep 291 day+31 pts
Apr 2, 2020Apr 62 days+264 pts
Aug 9, 2024Aug 131 day+58 pts
Mar 27, 2020Apr 12 days+163 pts

The system doesn't hold grudges

Some of the biggest winners came immediately after a stop-out. Trade 5 (+264 pts, 26 days) entered just 2 days after Trade 4 was stopped. If you'd sat out to "wait and see," you'd have missed $1,320.

This is why mechanical rules matter. After a loss, your instinct is to hesitate. The system's instinct is to take the next valid signal. The data shows the system is right.

Check your understanding

Price made 2 consecutive higher highs yesterday. You entered at today's open per the rules. Today the market gaps down and closes below the SMA(20).

What do you do?

A) Correct. The entry signal triggered at yesterday's close. You entered at today's open. That's done. What happens after your entry is the stop's job, not yours.

The SMA(20)-3 trailing stop will handle the exit. If price keeps falling, the stop catches you. If it recovers, you're in the trade. No discretionary overrides. No second-guessing. The whole point of mechanical rules is that you follow them mechanically.

You know the edge, the signal, and the rules. Module 4 explains why the exit mechanism is more important than the entry.

Module 4: The Stop IS the Strategy →