It shifts using a shift collar with notches at each end, that match up with another set to the right or left, depending upon if you are shifting up or down, as the other poster said, it's basically an unsynchronized transmission, and you have to match the engine speed, ground spreed and main transmission gear up to which way you are going with the two-speed or it won't be able to "catch" and you will hear that ratcheting sound.
Typically, there's 10W oil in the actual shift mechanism, and heavy gear oil in the rear axle with a rubber boot/seal where the two-speed attaches to the axle. If that boot/seal tears/fails heavy gear oil gets in the two-speed shift unit, making for a slow shift that aggravates any tendency to miss a shift/grind.
Mite want to take a look at the two-speed unit and open up the little fill plug and see what's in there, light oil, no oil, heavy oil, or watery oil. At the very least it would be a good idea to drain it and put in fresh clean oil.
BTW, did you get the taillight issue figured out, maybe I missed the resolution to that?
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