Pinocchio bars

By Martin Pring
Technical analysis is pretty good at identifying trend reversals at a relatively early stage and allowing you to ride that trend. That should be good enough for most of us, but many traders would also like to consistently predict the duration and magnitude of the next trend. That’s not possible, of course, but there are some instances where specific setups or characteristics are often followed by above-average price moves.

Typically, these develop from “whipsaw” or false moves. Traders trapped on the wrong side of a whipsaw are forced to unwind their positions, while others position themselves in the direction of the true trend, resulting in two strong forces at least temporarily working in unison. Here, we’ll examine one type of whipsaw, called “Pinocchio bars” because, like the Disney character, they lie to us about the true direction of the trend.

Pinocchio’s nose gets bigger the larger the lie. In the case of the Pinocchio bar, the bigger its “nose,” the more significant the whipsaw. Although the following examples are drawn from daily charts, the concept is valid for any time frame and the principles of interpretation remain the same; only the significance is different. For example, it is reasonable to expect a Pinocchio bar to have an effect on prices for five to 10 bars. A pattern of this nature that appears on a monthly chart will have a much longer influence than one on a 10-minute chart.

Basic characteristics
A bearish Pinocchio bar forms when the intraday price action takes price decisively above a resistance zone but the opening and closing prices do not. The most common forms of resistance in this respect would be a previous high or a trendline. In Figure 1, for example, price moves decisively above the previous high on an intrabar basis, but by the close it is below it. In this example, price hesitates for a couple of bars prior to moving much lower. This hesitation is quite normal and gives traders an additional opportunity to enter a short position.




For the complete article, see the March 2010 issue of Active Trader magazine. Click here to subscribe.



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