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What is Tape Reading and How Does it Work

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When new-age traders, sitting behind their powerful computers and trading terminals, hear the term “tape reading”, they usually think of something ancient. Although the term brings up distant memories, it is worth noting that, it is still present in the toolkit of day traders today. The main difference is that instead of on the old ticker tape, the process takes place electronically. In the following article, we will examine what is tape reading, its pros and cons, and how it can help you improve your trading performance.

Table of Contents:

What is Tape Reading?

Tape reading is an old technique for analyzing price and volume data for a particular stock. It represents the number and the type of trades taking place on the market and the price agreed by the buyers and sellers.

Tape reading is used mostly by day traders who build their strategies upon intraday trading information. Tape reading was used by some of the most prominent traders, including Jesse Livermore, the father of momentum trading.

If you want to deep-dive in the concept of tape reading, consider starting from books like Techniques of Tape Reading, Tape Reading and Market Tactics,  and Reminiscences of a Stock Operator.

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History of Tape Reading

The concept of tape reading first emerged in the late 1860s. That was when traders started using ticker tapes to transmit trading information. Experts generally consider Edward A. Calahan the father of tape reading. At the time, he was an employee at the American Telegraph Company.

The tape reading technique became mainstream in 1869. That was the year Thomas Edison developed the first stock ticker. Soon after, these practical tools were installed across all the major brokerages around the US.

The ticker tape included intraday information such as the ticker symbol, the price, and the volume. Tape reading remained the dominant method for transmitting trade information until markets became electronic in the 1960s.

To some extent, tape reading became obsolete as soon as electronic communication networks (ECNs) were introduced in the 1970s. The rise of computers and media made markets more accessible. For traders, this meant that the old ticker tape was no longer that efficient.

However, tape reading is not entirely a thing from the past. Today, it is still used by some day traders, although in a similar, but also a much more evolved form. The ticker tape today is called an electronic order book.

Why Use Tape Reading?

There are several reasons. The most important one is getting a clearer understanding of the market environment and the participants’ behavior.

In the day trading world, there is a split between tape readers and chartists. In other words, traders who analyze data from the order book and others who look at charts and employ indicators to get trading signals.

The benefit of tape reading for day trading is that you get access to real-time intraday data. This is invaluable for short-term price forecasts. When combined with long-term trading strategies, tape reading can help improve efficiency. It does so by confirming or rejecting your theories on an intraday basis. This makes it a useful tool to complement your long-term trading strategy.

Many advanced day traders fancy tape reading as it helps them spot unfair trading practices. These include order cancellation, price manipulation, and others, often applied by high-frequency trading companies, algorithmic traders, and more.

To understand how they do that, we should first point out that, nowadays, day traders employ modern tape reading techniques based on an electronic order book. Aside from the typical information present in the “old-school” ticker tapes, electronic order books also include data for non-executed orders. Non-executed orders are often canceled intentionally, which means they might indicate some sort of a market manipulation tactic.

The rich amount of information that modern tape reading provides also helps day traders get a glimpse of the way other market participants feel about particular instruments and better predict their prices.

How Does Tape Reading Work?

Understanding tape reading works isn’t rocket science. In fact, the basics are very simple and easy-to-understand. Think of it as a mix of several factors, including the price of the instrument, the volume, the bid and offer price, and the bid and offer size. By combining these factors, traders get a more complete picture of the market. However, the harder part is understanding how to effectively combine all these.

To do that, first of all you should get familiar with the information included in the tape, also referred to as “Time & Sales”.

The time and sales info indicates real-time data about the transaction timestamp, the price levels, the trading volume for the particular instrument, and the best bid or offer. In a nutshell – it shows transaction information However, this doesn’t say much about what is going on in financial markets and the market structure of the price action. To get a clearer picture, traders also look at the DOM (depth of market).

DOM complements the information from the Time & Sales by revealing more details regarding the auction process of the limit orders depth (the supply and demand for the particular instrument). The DOM also informs you about the last transaction, the current levels of the bid and the offer, and their depth. This is important because it helps make markets more transparent and easier to recognize unfair market manipulations like spoofing. Depth screens are also referred to as “Level II” quotes.

Mastering tape reading requires familiarity with the way financial markets work, how their individual parts interact with each other, what affects the prices of instruments (both on a micro and macro levels), etc.

Tape Reading Trading Strategies

Experienced day traders apply a variety of tape reading strategies that allow them to:

Identify support and resistance levels

Traders often look for large limit sell/buy orders in the order book of the particular asset among multiple trading venues. If there are such, then the asset’s price is expected to experience strong resistance/support at the specific levels.

By applying this strategy, traders can get a sense of whether it is a good idea to trade the particular asset and where the price floor stands. That way, they can estimate the associated risk and better plan their trading moves.

Order book information (Level II quotes) can be accessed through the platforms of the most popular brokers. Some of them even allow you to integrate it directly and feed your trading algorithm.

Ride the wave

Always remember that you can use and benefit from other market participant’s momentum. A preferred way to do that usually is through tape reading.

The best traders realize they don’t have to do everything on their own. All they have to do is identify a high-potential opportunity and start building up their positions. If the opportunity is good enough, the market will follow, and the rest of the traders will create a momentum that you can ride and profit from.

Let’s take a look at how to do that. When the trading session opens, wait for the chaos, typical for the first trading hour to settle down. Then start looking for instruments that start ticking up slightly. Pay close attention to their order books and find out whether bigger orders are beginning to pop up. If, let’s say, there are a number of orders for 500 or 1,000 shares/futures contracts, this is a signal that the market has a positive sentiment towards the particular instrument.

Next, if you see the ask and the bid prices going up, it means buyers are willing to pay more, while sellers are looking to take more as they have realized the potential of the instrument. To get additional confirmations, make sure also to keep an eye on the trading volume and whether there is a spike in it.

This is when you should start adding to your position. The market does the rest. The bigger players and those placing the larger orders will carry you and your position further.

Avoid leaving a profitable position prematurely

No trader had ever seen the market going continuously in his favor. There are sideways moves, trend slow-downs, or momentum reversals. This, however, doesn’t mean losing is inevitable. Just the opposite – the skill to identify when to keep your position open is what will define your success.

Here is how tape reading can help you with that. Assume that you are willing to sell the AAPL stock. The tape shows that, throughout the trading session, there have been prints for over 1,000 shares. Suddenly, the stock’s price jumps, which opposes your position. When you look at the tape, however, you see that the reason for the spike was merely the trading of just a few shares.

The experienced tape reader will know that sustainable bullish price moves require a much bigger volume to survive. In the example, the spike lasts a brief time, and you should stay within your position. The thing is, however, tape reading is what allows you to easily find out these small details that might have otherwise forced you to close your position.

Advantages and Disadvantages of Tape Reading

The best way to evaluate whether a particular trading strategy or analysis technique is suitable for your trading style is by considering its advantages and disadvantages. Here are the most popular pros and cons of tape reading:

Advantages of tape reading

A great tool for pricing insights

Even a basic understanding of tape reading will provide you with enough information to get a clear representation of the intraday fundamentals, bid/ask imbalances, trading volume, the frequency, etc. 

When you step up and become a better tape reader, you will be able to recognize even small spikes and mounting pricing pressure. You will also be able to derive conclusions from the number of orders, canceled right before execution, their position in relation to the NBBO, and even trade mean-reversion strategies.

Helps day traders time their exits

Day traders who lack experience struggle from one primary problem. That is staying in a trade for too long just because of their ego. It is the desire to be right, emotions, or inability to withstand the heat of the moment.

Tape reading helps traders overcome this and make better short-term trading moves by bringing small, but valuable signals regarding other market participants’ behavior. By analyzing the changes in the bid/ask price, along with the volume, you will be able to spot momentum building up and make an informed decision on whether to stay or leave the market.

Hint: To become a better tape reader, make sure to record your screen. Once the trading session is over, go through the recording, and see how your trades have panned out. This will help you act better next time.

Suitable for beginners and pros

Let’s be clear, tape reading isn’t easy, especially when it comes to applying some of the above-mentioned professional techniques. However, this doesn’t mean it is entirely out of the beginner’s league – just the opposite.

If you are just starting, you can use tape reading to analyze only the single instrument that you are familiar with and willing to trade. There is no need to follow multiple assets or markets simultaneously until you learn the basics.

Beginners usually start with low-priced stocks (in the range of $50 – 60$ per share or less) and over $1m daily trading volume. Traders consider these instruments the most favorable in the process of building your tape reading skills.

Disadvantages of tape reading

Time & Sales and DOM might be hard to navigate

Although widely used, the screens aren’t perfect. Among their main cons is that they might be very hard to keep track of or navigate. In many platforms, they come as separate tools designed as numerical displays that change rapidly. This requires extreme focus and quick decision-making skills.

Aside from that, they are no historical representation, no matter whether examined over long or short time frames. This prevents you from getting a complete overview of the order book. If you want to look at the past performance at the same time, you would have to include a third screen as well, which may further challenge your focus.

Requires laser-focus

In a world where over 70% to 80% of the trading takes place algorithmically and at milliseconds speed, price action unfolds rapidly. If you want to be a really good tape reader, you should focus on your ability to make decisions in an extremely fast-paced environment. Often, you will realize information comes and goes without being able to even take a glimpse of it. Considering this happens in large volumes, the chance is if you don’t have the mental focus, you might get distracted and confused by the rapidly changing information and get left in the dust.

This also makes it hard to distinguish market manipulation techniques like spoofing, order ignition, etc., from the real market events.

Inefficient as a stand-alone analysis tool

The key to becoming good at tape reading is the ability to capture the hundredths of small lots of transactions that appear on your screen, especially when you follow several markets and instruments simultaneously. The problem here is that critical information like the liquidity volumes only has a brief use. It passes through your screen and is never recorded. This prevents you from finding out how long the liquidity was present, whether it was pulled out intentionally, or transferred to other markets.

Tape reading can’t give you a complete representation of the things that are truly happening on the market, including market structure, depth of liquidity, etc. That is why you should always complement it with an integrated market view, other indicators, or traditional fundamental and technical analysis tools.

Examples of Tape Reading

There is no better way to understand how you can apply tape reading in your day trading activities than going through an example of a whole trading session. To better understand it, let’s divide the trading session into separate phases.

Pre-market session

You can start the day with tape reading of the overnight events. For example, check out your preferred instrument (i.e., E-mini S&P 500) at an hourly chart for the last 24 hours. Compare the index’s performance in relation to other benchmarks like the U.S. Treasury bond futures or the NASDAQ 100. If the S&P 500 leads, and there is a strong performance of the bond futures, it might indicate adverse events on the international scale and the potential for a more cautious behavior among other traders.

The start of the trading session

Look at how your preferred instrument opens. Bear in mind that the relation between the price swings and the opening prints indicates who will be in control of the market. A stronger bullish sentiment is typical for levels above the opening values. Meanwhile, you expect bears to take over if the levels are below them.

Another thing to do during the first hour of the trading session is to look for the VIX levels. A red VIX after the first hour signals the presence of market speculators that favor higher prices. A rising VIX indicates fear among traders that may lead to lower prices.

Midday session

The tape reading trader will also look for the events taking place between the first trading hour and the middle of the trading session. He would consider the opening prints and how the price has gone after that. This may help him spot inflection points that may lead to price breaks or reversals. These moves help traders find out whether it is a good idea to add to their intraday positions or serve as exit signals.

Throughout the midday session, tape readers are usually very cautious as other markets start opening, and the trading activity grows. This may lead to U.S. indices breaking key price levels and a change in the volatility levels.

The end of the trading session

If the tape reading trader has identified specific intraday patterns, he expects them to mature during the last trading hour. The last 30 to 15 minutes of the trading session is usually the period when prices surge or nosedive as many day traders (algorithmic ones as well) try to close their positions to hedge against risks associated with holding instruments overnight.

Is It Worth Using Tape Reading Today?

The answer depends on whether you are willing to deep-dive in the concept of tape reading. Understanding the way it works and the basics is one thing. Learning how to apply it successfully, however, is something entirely different. If you have the time and dedication to explore the topic in detail, it is definitely worth using it today. It will give you that bit of expertise that many traders lack. It will also complement your short- and long-term trading strategy in a way that few other methodologies can. Whether it is on an intraday level or otherwise.

It is also important to note that many argue that tape reading today is inefficient. They claim there is no point in learning how to do it due to how complex the market and the actions of the participants have become in the recent years (i.e., large block traders, high-frequency traders, algorithmic traders, etc.).

However, many don’t know that often, these advanced traders aim exactly at manipulating the tape, thus influencing the price of their preferred instruments. If you are unaware of this risk, how will you make sure that you trade in the most optimal way? In fact, the boom in this type of trading activity has made advanced tape readers even more precise at what they do. Today, they take way more market inputs into consideration than they ever did.

Final Thoughts

In a nutshell, tape reading might not be the top skill required to be a successful trader. However, it certainly distinguishes the best ones. Even if you don’t plan to apply it regularly, there is no harm in understanding how the depth of the market and the time and sales work.

However, if you are taking your first steps in trading, make sure to focus your efforts on understanding how financial markets work and what affects the price of an instrument. Focus on technical and fundamental analysis. Then, once you feel comfortable with these, make sure to deep-dive in tape reading to complement your short- and long-term trading strategies.

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