The art of “tape reading” goes back to the early days of stock trading when astute traders used to look for patterns in paper ticker-tape prices during strong moves, to profit from breakouts. Nowadays both retail home traders as well as professional traders can use a variety of practical tape reading skills to detect sustainable breakouts during intraday trading entries as well.
A major challenge that active traders face is avoiding “false breakouts”, which is when a trader buys a stock, expecting it to keep continuing, only to see it go back down in price, causing a stop-loss. Tape reading can help avoid false breakout entries, by helping traders gauge momentum, price action and volume, trade by trade, to help decide whether or not an entry is likely to continue moving in their favor. It’s a very powerful strategy, when used correctly.
How to Use Tape Reading For Entering Stock Day Trades
In this first article, we’ll look at the 3 basic columns to understand, and how to trade with them: Time, Price and Size. Tape reading uses the time and sales window along with a 1-minute two-day chart, as seen in Figure 1, [Haliburton (HAL)] to identify strong breakout patterns in progress. During market opens, the “tape” is scrolling down from top to bottom, showing trades as they are occurring in realtime.
This gives traders faster feedback than even a 1-minute chart does, because they can see the actual trades occur in realtime throughout the trading day. As you can see in the HAL 1-minute chart (Figure 1), a new breakout occurred from 33.8 up to 34.8 in several strong moves. Using one of several precision tape reading patterns, a smart day trader can correctly spot these breakout tape patterns in progress, and use them to help enter positions.
Tape Reading Pattern #1: Tape Speed (“Velocity” of Transactions)
One of the first patterns to understand is the difference between a “consolidating tape”, where price is stuck inside a congestion region (for example between 34.2 and 34.3 in the HAL chart), versus a “breakout tape”.
A tape is breaking out when the speed of the transactions is getting faster and faster, combined with an increase in price, as occurred in the HAL tape from 33.8 to 34.2 earlier in the session.
What to look for: an increase in how fast transactions occur during a given 1- to 2-minute timeframe. When the tape (or transaction speed) gets faster and faster, you can anticipate a stronger likelihood of a continuation in price after an entry trigger is hit.
Tape Reading Pattern #2: Tape Price Action (“Micro-Breakouts” Above Each .10-cent Increment)
Especially useful when trading equities priced less than $30 share is the “ten cent” rule to use with tape reading. For these lower-priced high-volume (over 15k shares/minute) stocks, every ten cents worth of price action is a major move, with each “dime” being a key micro-support or resistance level. So using the tape to wait until price breaks above each multiple of ten cents can help avoid false breakouts, while getting in on strong breakouts.
For example in Figure 2 [Leap Wireless (LEAP)], a strong 1-point breakout was spotted using this ten-cent rule with the tape, shown at left. Each move over every ten-cent increment (for example, over 8.8, 8.9, 9.0, 9.1, 9,2 and so on) made for a new “micro-breakout” tradable entry signal.
What to look for: when trading inexpensive stocks, wait for the tape to break above each multiple of ten cents before entering the trade. Note that it’s recommended that traders only day trade stocks that trade at least 15k shares per minute, to avoid low liquidity and wide spreads. This ten-cent rule helps avoid false breakouts when for example a trader might enter at 8.87, have it stall out at 8.9 and drop back to 8.5, triggering a stop loss, or similar mistakes. Instead, waiting for the 8.91 or higher to enter would be a better entry signal.
Tape Reading Pattern #3: Tape “Block” Trades (Institutional Traders Tip Their Hand)
When market makers and specialists have to work their order flow into the market, they do so using what are called “reserve” orders. This means they may for example buy 20,000 shares of a stock, but do so with automated programs that only buy 100 to 300 shares at a time, to avoid showing that they are strongly interested in buying. However, when price action starts to move to fast, they override these “reserve order flow” orders and need to buy in larger “blocks” of over 400 shares.
Professional day traders know to look for “blocks in the tape”, as seen in Figure 3 [Canadian Pacific Railway (CP)], where a block trade of 2200 shares appears at price 65.7, right before a dramatic 2-point move up that occurred in just minutes after this “block” transaction was printed.
What to look for: when a tape that previously had a series of 100-300 share transactions suddenly starts getting transactions printed of over 400 shares (as in this CP 2200-share trade), immediately followed by higher prices, this is often a strong momentum breakout “buy” signal to look for in the tape.
Using the “Patter” of the Tape For Day Trading
Note that single transactions by themselves are meaningless in the tape; what counts is the “story” or the “patter” of the tape. This means, look for 15-20 seconds worth of data in the tape to help gauge what the overall buy/sell pressure is in the equity being traded. This “patter” of the tape (as it’s been historically known), once understood and traded correctly, can provide a retail trader with significant advantage over traders who do not know nor understand how to use dynamic tape reading.
As always, the signals generated by individual tapes should be combined with broad market internals and other indicators to help make specific trading decisions. By harnessing the power of these simple (yet effective) stock tape reading strategies, active traders can trade on a more level playing field with professional traders and potentially avoid more false breakouts. Selectively trading strong entries based on tape reading signal strength is one key to successful active trading.
In the second of this 2-part article series, we’ll look at even more advanced precision tape reading strategies with the “Sizes” column, and more.
Ken Calhoun is a trading professional who has traded millions of dollars of equities since the 1990s, and is the producer of multiple award-winning trading courses and video-based training systems for active traders. He is a UCLA alumnus and is the founder of DaytradingUniversity.com, a popular online educational site for active traders.