2 Close Reversal
The 2 Close Reversal is a type of key reversal. The primary difference is the confirmation point provided by the second close prior.
A key reversal (Figures 1 + 2) is the most basic of reversal patterns and involves a market trading higher than the previous day's high (intraday) and then closing below the close of the previous day OR trading below the low of the previous day's low (intraday) and then closing above the close of the previous day.
This is such a diluted pattern that a confirmation point is necessary to validate a reversal. This is where the 2 Close Reversal comes into play.
The 2 Close Reversal (Figures 3 + 4) adheres to the same rules as the key reversal, but requires a close below both the previous day's close and the close of 2 days prior - after trading above the previous day's high - or above both of those closes after trading below the previous day's low.
This pattern is important when judging the validity of an outside-day reversal. Most outside- day reversals (a high above the previous day's high AND a low below the previous day's low) are more significant than a plain key reversal. This gives them a higher probability factor, right from the start.
However, when a market gaps higher on the day preceding a reversal -- and then provides an outside-day reversal on the ensuing day - the 2 Close Reversal becomes very important. (Figures 5+6 show an unconfirmed outside-day reversal; Figures 7+8 show a 2 Close Reversal outside-day.)
At this point, it coincides with gap rules and true-range theories, requiring the outside-day to close below the ‘2nd Close’ prior to validate the reversal. By doing so, it closes the gap created by the day preceding the reversal. By textbook gap rules, this would invalidate that gap and remove the support thought to exist there - resulting in the reversal having a better chance of following through. (The inverse applies to a gap lower and subsequent reversal higher.)
[Additional details & diagrams can be found in Eric Hadik's Tech Tip Reference Library]