How Do You Actually Use Tape Reading In Your Trading?
People are either for tape reading or against it. There is a lot of incorrect information out there written about tape reading and it’s usefulness in trading. To put it simply, tape reading is identifying buyers and sellers on a specific stock, index, or futures contract, based on the transactions that we see in Time and Sales, in combination with how the bids and offers are acting.
The time and sales is a reflection of buyers and sellers who agree on prices, and thus make a trade. That information alone is almost useless, unless you consult it in context with the level2, or bids/offers. As a side note, dark pool transactions are another variable to factor in here; these are just one of many nuances to tape reading to keep in mind. The topic itself is worth a lifetime of learning.
Since the advent of electronic trading, Tape Reading has found itself on the forefront of representing HFT, large block traders, small traders, semi pro traders, etc. Many say that it is impossible to “tape read” effectively, due to the confluence of so many actors.
So how can humans keep up with this fast-paced method of trading? Well, we do what the computers can’t: we adapt.
By understanding that there are ways to manipulate the tape, you are already ahead of the rest of the pack who are largely still ignorant to this fact. But how do you know what is regular retail versus an institution or HFT program? Well, it’s tough, to say the least.
The idea here is to use Tape Reading as a supportive measure on your actual trade strategy. How to do that? Well, we offer a course here at TheDayTradingRoom.com that goes in depth on how to utilize tape reading strategies.
You must develop an opinion on sentiment, or reason to be in a trade; define this first. Secondly, don’t bother looking at every single tick and every single transaction. Your job is to reinforce why you are going into a trade, why you are staying in a trade, and why you are exiting. These are usually defined with levels. So, the obvious application here is to read the tape around significant levels.
You must be able to determine if the wave of buyers/sellers are still on your side. If you are operating on a multi-hour level, think on that level, and what others would be doing if they were sensitive to price in the way you are. A big buyer can be spotted pretty easily on “support” levels, for instance.
Another key point to keep in mind is reaction time in fast moving markets. Big players are less price-sensitive in fast moving markets. They are worried about either missing the trade, or getting out. What does this mean? Well, it means that they are less likely to “work” their orders, that they become less price sensitive, and that they’ll reach across the market and remove liquidity. This is another key indication on the tape to consider.
So, with that said, you’ve now seen the tip of the iceberg. Understanding the participants in the market is the key to Tape Reading, as well as to developing your own trading strategy.