Five classic setups written as rules you can test

🎯 In 30 seconds: A setup is only testable when two people reading the same rules would mark the same bars. This chapter writes five well-known ideas that way: a pullback in a trend, a 20-day breakout, a volatility squeeze, a short dip in an uptrend, and a bullish engulfing candle near support. Each has a context filter, a trigger, an entry, a stop and an exit. None comes with a promise. They are starting points for your own records, checked with the chart tool and then in paper trading.

What makes a rule testable

“Buy strong stocks on dips” cannot be tested. Strong compared with what? How deep is a dip? When do you get out?

Every rule below has five parts:

Context. The background condition that must already be true.
Trigger. The bar that says “now”.
Entry. Always the next bar’s open, so the rule never uses a price you could not have traded at.
Stop. A fixed rule, written in ATR or a recent swing.
Exit. A target, a trailing rule or a time limit, whichever comes first.

All five are written for daily bars and the long side. Each has a mirror image for falling markets. The numbers (20 bars, 2 ATR, and so on) are ordinary round choices, picked before any testing. That matters, as Testing an idea explains.

Setup 1: trend pullback to the 20-day EMA

Context. Close above the 200-day SMA, and the 50-day SMA higher than it was 10 sessions ago.
Trigger. At least three of the last five bars closed lower, the low of one of them touched or went below the 20-day EMA, and today closes above the previous bar’s high.
Entry. Next open.
Stop. Lowest low of the last five bars, minus 0.5 × ATR(14).
Exit. Target at +2R, or the close of the 10th bar after entry, whichever is first.

Hypothetical. Three down bars dip to the 20-day EMA. The trigger bar closes above the previous bar’s high. Entry is the next open, and the stop sits under the five-bar low with a half-ATR buffer.

Setup 2: 20-day range breakout with volume

Context. Close above the 200-day SMA.
Trigger. Today’s close is above the highest high of the previous 20 bars, and today’s volume is at least 1.5 times its 50-day average.
Entry. Next open.
Stop. Entry minus 2 × ATR(14).
Exit. A close below the lowest low of the last 10 bars, which trails up as the trend runs.

This one has no target. It accepts many small losses in the hope that a few trends run far. Its records usually show a low win rate with uneven, large winners.

Setup 3: volatility squeeze, then a close outside the band

Context. The width of 20-bar, 2-standard-deviation Bollinger Bands® is at its lowest of the last 120 bars, within the last five bars.
Trigger. A close above the upper band.
Entry. Next open.
Stop. The 20-day SMA (the middle band) on the trigger day, minus 0.25 × ATR(14).
Exit. A close below the middle band, or after 20 bars.

Hypothetical. The bands pinch together while price drifts sideways. The circled close above the upper band is the trigger. Squeezes can break either way, which is why the context rule only measures quiet, not direction.

Setup 4: a short dip inside an uptrend

Context. Close above the 200-day SMA.
Trigger. RSI(14) closes below 40.
Entry. Next open.
Stop. Entry minus 2.5 × ATR(14).
Exit. RSI(14) closes above 55, or after 7 bars.

This is a mean-reversion idea. It tends to win often and by small amounts, so a few large losses can erase many small gains. Test it with and without the stop to see how much the stop changes the record.

Setup 5: bullish engulfing candle near support

Context. Today’s low is within 1 × ATR(14) of the lowest low of the previous 20 bars.
Trigger. A bullish engulfing pair: yesterday closed lower than it opened, today closed higher than it opened, and today’s body covers yesterday’s whole body. Volume is above its 20-day average.
Entry. Next open.
Stop. The pattern’s low, minus 0.25 × ATR(14).
Exit. Target at +2R, or after 10 bars.

Candle definitions vary. If the tool’s marker uses a slightly different definition, write down which one you used and keep it.

The five side by side

Setup	Style	Typical shape of results	Tool feature to start with
1. Trend pullback	Trend following	Middling win rate, fixed 2R winners	EMA and SMA overlays
2. 20-day breakout	Trend following	Many small losses, few big wins	Chart events: new highs, volume surges
3. Squeeze break	Volatility expansion	Uneven; false breaks are common	Band width indicator
4. Dip in uptrend	Mean reversion	Frequent small wins, rare large losses	RSI and the 200-day SMA
5. Engulfing near support	Reversal	Depends heavily on location	Candle patterns and Pattern record

These “typical shapes” describe how the rules are built. They are not tested results. Your own records decide what each one does.

How to check a setup in the tool and on paper

Write the rules first, on paper or in a note, exactly as above or with your own changes.
Use the markers to find candidates. Tick “Chart events” to see crosses, gaps, volume surges and new highs and lows. Tick “Candle patterns” to see marked patterns. These show you where to look. Then check each candidate against every rule by eye.
Read the Pattern record tab for Setup 5. It shows what followed each candle pattern on this stock compared with the base rate, which is what happened after an ordinary day. A pattern that does no better than the base rate is not adding information on that stock. The record covers the pattern in general, without your location rule, so treat it as a first look.
Log every occurrence, including the ugly ones: date, entry, stop, exit and result in R. Aim for at least 30 across several stocks.
Paper trade it forward in the paper portfolio for new signals as they appear, without changing the rules.

Watch out

Scrolling back through a chart and marking setups by hand is easy to bias. Your eye skips the failures that looked messy. Mark every bar that meets the rules, then look at the result. Research on candlestick rules applied to large U.S. stocks found they did not add value after testing (Marshall, Young and Rose, 2006), and broad surveys warn that many positive results come from weak testing. Treat each setup as unproven until your own complete record says otherwise.

Try it on the chart

Open Technical Analysis on a large, liquid stock with daily bars and two years of history. Add the 200-day SMA, the 50-day SMA, the 20-day EMA and ATR from “＋ Indicators”. Tick “Chart events”. Zoom in with Ctrl and scroll, drag the chart to move through it a few bars at a time, and log every bar that meets Setup 1. Then open the Pattern record tab and read how bullish engulfing has done on this stock against the base rate.

Check yourself

Why is the entry always the next bar’s open? Answer: The trigger needs today’s close, so the first price you could actually trade at is the next open.
Which setup has no profit target, and why? Answer: The 20-day breakout. It trails a 10-bar low so that rare long trends can run.
What does the Pattern record tab compare a candle pattern with? Answer: The base rate: what followed ordinary days on the same stock.
Why log every occurrence, including messy ones? Answer: Picking only the clean-looking examples makes a setup look better than it is.

Sources

Steve Nison, Japanese Candlestick Charting Techniques (1991), engulfing patterns.
John Bollinger, Bollinger on Bollinger Bands (2001), band width and squeezes.
J. Welles Wilder Jr., New Concepts in Technical Trading Systems (1978), RSI and ATR.
Brock, Lakonishok and LeBaron (1992), “Simple Technical Trading Rules and the Stochastic Properties of Stock Returns,” Journal of Finance, on moving average and range breakout rules.
Marshall, Young and Rose (2006), “Candlestick technical trading strategies: Can they create value for investors?” Journal of Banking and Finance.
Park and Irwin (2007), “What Do We Know About the Profitability of Technical Analysis?” Journal of Economic Surveys.
Moneydesks Technical Analysis tool: Chart events, Candle patterns and the Pattern record tab.