Using precision “tape reading” skills is one of the most useful skills that an active day trader can acquire. In our first part of the article, we covered several tape reading patterns to use, in addition to showing how tape reading is used to avoid false breakouts and enter momentum day traders. In this second and final article, we’ll look at advanced strategies and how to “trade the tape” like professional day traders.
Think of tape reading like a golf swing -- raising the club to prepare to hit the ball is what tape reading is similar to; you’re waiting for the precise time to pull the trigger on the trade, when energy is at it’s highest. In tape reading, we’re looking for several key signals to “line up” to help enter a position during a momentum breakout when price action starts to finally escape consolidation ranges and take out new highs.
How to Use The “Sizes” Column When Tape Reading
Advanced tape reading uses the time and sales window along with a 1-minute closeup chart, as seen in Figure 1, [Harley Davidson (HOG)] to identify strong breakout patterns in progress. Combined with the 2-day 1-minute chart (as discussed in the earlier article), it gives a very close look at specific price action as it occurs.
In this breakout chart of Harley Davidson from Friday, January 13th 2012 you can see the price moved up a full point, from 40.4 to 41.4 before retracing. The “tape” window at left shows what the actual trading tape looked like right after the opening bell, at 9:32am ET. One key indicator to look for is an imbalance in the rightmost “Sizes” column (this column shows the inside bid x ask that’s being quoted for this equity by market participants, scrolling from top to bottom in real time during market hours). What you look for is when 15-20 seconds of the leftmost “Sizes” column number (in this case, bids), is larger, on average, than the rightmost column of numbers. This indicates a likely breakout is in progress.
In the HOG example, you can see that there were a lot of “Sizes” pairs in which the leftmost [bid] number was larger than the rightmost [ask] number: 3x1, 3x2, 2x1, 3x1 and so on. When you see this in the tape, combined with an increase in share price (for example 40.44 to 40.45 and beyond, in this case all the way up to 41.4), it indicates a “Breakout Long Tape” is telling you that this is a good long candidate to enter, during the first 20-30 cents of price action (in this case, from 40.44 to 40.75 or so).
Tape Reading Pivots: When Prices Reverse
It’s also important to be able to use tape reading during the first hour of the market open to detect price reversals. This helps manage trading entries correctly, and help the astute day trader exit trades that are going against them earlier. For pivot entries, see Figure 2 [Citigroup (C)], in which the tape showed a reversal pattern right after the 1-minute hammer that occurred near 9:30am ET.
As with the earlier example, you can see that the leftmost “Sizes” columns numbers (indicating buyers) were all larger than the rightmost numbers (13x2, 15x2, 17x2 and so on). This occurred as the price pivoted at 9:32 to the long side. A smart day trader can see then that with two confirming technical signals (long hammer, plus long tape reading pattern), a buy signal is generated.
Tape Reading Sell Offs: When To Short
Since day traders trade both long and short entries, it’s also instructional to look at the exact opposite tape reading pattern, a “short” tape, as in Figure 3 [Lam Research (LRCX)]. In this tape, you can see in the “Sizes” column, how the rightmost “ask” numbers are larger than the left “bid” numbers. This occurred during the open, right after the opening bell at 9:33, in which the columns looked like: 1x11, 1x13 and so on. This indicates sell pressure in the tape, so this is a stock to day trade to the short side.
Tape reading using these professional trading patterns is also helpful for swing traders who may be watching the tape live during the market open, to help decide to stop-out of an overnight open long position, if they see a sell-off tape like this during the first hour of the market open.
Advanced Tape Reading: How To Get Better With Skill-Building Activities
As with anything, observation and practice over the course of many years is the best way to get better at tape reading. There’s a few activities that active traders can use to help build their tape reading pattern recognition skills:
Activity 1: For a stock that you’re familiar with, watch the tape during the first 20 minutes of each trading day on those [occasional] days in which it’s taking out a new 2-day high or low. What patterns do you see in terms of “sizes” column imbalance, price action and momentum?
Activity 2: Once a stock has moved to the edge of it’s Average Trading Range (ATR), watch the tape to see if you can detect the “shift” from buying to selling (or vice-versa), to help you identify likely pivots and price reversals.
Activity 3: Focus your energy on spotting times in which both the price is changing quickly and the “speed” of the tape is increasing during breakouts. Taking time to learn the intricacies of tape reading price action can potentially make a big impact in day trading success, because of the precision and accuracy that this skill helps traders develop.
Tape reading can be a useful part of any active day (and swing) traders’ arsenal of skills, when used properly. It provides immediate price-action feedback much faster than even 1-minute charts, since it’s a tick-by-tick live real time record of what’s occurring in each stock’s price action.
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.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer