Last Updated on 19 September, 2022 by Samuelsson
Tape Reading: What Does It Mean? —Definition and an explanation?
“Of course, there is always a reason for fluctuations, but the tape does not concern itself with the why or wherefore. It doesn’t go into explanations. I didn’t ask the tape why when I was fourteen, and I don’t ask it today at forty…” These were the words of Jesse Livermore, one of the greatest traders ever lived, about a century ago, and tape reading still resonates among today’s experienced traders. But what does tape reading actually mean?
Tape reading is the oldest trading technique used by traders to analyze the price and volume of stocks. The term originally referred to the actual reading of the old-style ticker tapes that traders watched to get their market data, which included a ticker symbol, price, and volume. While tape reading still happens today, the rise of personal computers and electronic communication networks (ECNs) mean that those market data are updated with computers, data feeds, and Level II quotes.
To cover all you need to know about tape reading, we’ll discuss the topic under the following subheadings:
- What is tape reading?
- The origin of tape reading
- Why use tape reading?
- How tape reading works
- Advantages and disadvantages of tape reading
- Tape reading trading strategies
- Tips for mastering tape reading in today’s market
What is tape reading?
Also known as “time and sales” reading, tape reading is the oldest trading technique used for analyzing the price and volume of stocks. Before the emergence of PCs, the internet, and ECNs, stock prices were transmitted over telegraph lines on a ticker tape. The tape would include the stock ticker symbol, along with the current price and the volume traded.
Those market data represent the number and the type of trades taking place on the market and the price agreed by the buyers and sellers. Thousands upon thousands of traders and investors will read the tape in order to know what the stock price, volume were for a specific stock. This is how the expression tape reading gained popularity.
Thus, tape reading was the way day traders could analyze the price and volume of a given stock before the technology was replaced by the electronic transmission of price quotes and volume data. Although tape reading was phased out in the 1960s, similar strategies are used by electronic traders.
Interestingly, many of the terms originating from the time are still widely used; traders still use the term, “tape reading”, even though the days of the ticker tape machine are long gone. So what are they referring to now? Well, it’s obvious they are talking about reading the Time & Sales Window, which displays the following information:
- The real-time numerical values of a trading instrument’s latest transaction timestamp
- The price at which a transaction went through
- The trade volume or the size of the transaction
- The time of the trade
- And sometimes, the transaction location on either the best bid or offer
Tape readers take advantage of these real-time market data to improve their trading decisions. It may be fair to call tape reading an ancient art, and as with any art, it requires practice, even more practice than does chart reading. Many experienced tape readers don’t often look at the price charts, because they believe that chart indicators and patterns lag the actual price action. They think of tape reading as an equation with multiple variables — price, volume, bid price, offer price, and bid and ask size. By combining these variables, they can make sense of a stock’s trend during a given time frame.
The origin of tape reading
The origin of tape reading can be traced to the era of the Ticker Tape machine, which became a popular technology for quoting stocks back in the late 19th century. The machine allowed traders to read updated stock quotes via morse code over telegraph lines; traders read these paper tapes and made decisions by interpreting the information on them.
Actually, it was in the late 1860s that traders started using ticker tapes to transmit trading information, so tape reading must have started around that period. Edward A. Calahan created the first ticker tapes for the American Gold and Stock Telegraph Company in 1867, which is why he is generally considered the father of tape reading.
Between 1869 and 1871, Thomas Edison developed the first practical stock ticker, which helped the market become more efficient. Soon after, these machines were soon installed across all major brokerages as the primary means of price and volume dissemination. As a result of this, tape reading became mainstream.
The ticker tape included intraday information, such as the ticker symbol, the price, and the volume. Traders would read the tapes to get live information about various stocks. Many famous traders, including Jesse Livermore who pioneered momentum trading, made a name for themselves by tape reading. Expectedly, several books were also published about tape reading, including Tape Reading and Market Tactics and Reminiscences of a Stock Operator.
Tape reading remained the dominant method for transmitting trade information until markets became electronic, with the rise of television and personal computers, in the 1960s. To many, tape reading became obsolete as soon as electronic communication networks (ECNs) were introduced in the 1970s. For traders, the old ticker tape was no longer that efficient since the rise of computers and media made markets more accessible.
However, tape reading is not entirely a thing from the past. Some day traders still employ many of the same techniques today, but with more modern technology — the ticker tape is now called an electronic order book. Moreover, many of the terminologies of that time remain in today’s trading vernacular. Examples include ticker symbol, stock ticker, and phrases like “don’t fight the tape” — which means, don’t trade against the trend.
Why use tape reading?
Reading the tape can be extremely helpful if you are a day trader looking to catch short-term moves, and there are several reasons for that. The most important one is that it enables you to get a clearer understanding of the market environment and the behavior of the participants. If you want to get to the roots of why the price is actually moving, you need to look at the data in the Time & Sales window (tape reading).
Among day traders, there is a split between tape readers and chartists — that is, traders who analyze data from the order book (tape readers) and others who look at charts and employ indicators to get trading signals (chartists). For tape readers, tape reading can be one of the most effective indicators for active day traders. It is a trend-leading indicator, as it shows the transactions of who is buying and who’s selling, so you can see the big orders that can drive the price.
In other words, it allows you to see what is going on behind the price chart. While chartists spend their time studying how to read a price chart and see where the flow of the market is going, a chart is only able to show those prices and trades that have already occurred. So, you are limited to the information you can get from trading technical analysis.
Thus, the key benefit of tape reading for day trading is that you have access to real-time intraday data that are very useful for short-term price forecasts. 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.
Also, if combined with long-term trading strategies, tape reading can help improve efficiency by confirming or rejecting your theories on an intraday basis. So, it can also be a useful tool to complement your long-term trading strategy.
Another reason why many experienced day traders always make use of tape reading is that it helps them spot unfair trading practices, such as order cancellation, price manipulation, spoofing, and others, brought about by high-frequency trading companies, algorithmic traders, and more.
This is possible because tape reading today is based on an electronic order book, which, aside from the typical information present in the “old-school” ticker tapes, also provides data for non-executed orders. Sometimes, non-executed orders are canceled intentionally, which means they might be from some sort of market manipulations.
How tape reading works
Tape reading isn’t rocket science; it’s easy to understand how it works, as the basics are very simple. Think of it as an equation with several factors, including the price of the instrument, the volume, the bid and offer price, and the bid and offer size. The aim is to combine these factors to get a more complete picture of the market. But the key is to know how to effectively combine all the data to arrive at the main information — what the market is likely to do next.
The first step to understanding how tape reading works is to get familiar with the information included in the tape, now called the “Time & Sales Window”. For most trading platforms, the info on the Time & Sales window includes real-time data about the transaction timestamp, the price levels, the trading volume for the particular instrument, and the best bid or offer. These are basically transaction information, which 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, you may have to look at the depth of market (DOM) or what they call the “Level II” market quotes. The information in the DOM (depth of market) covers the shortcomings of Time & Sales by displaying the various levels of the limit orders that make up the depth on the bid and offer. This shows the supply and demand in the market. DOM also displays the last transaction, the current bid or offer, depth on the Bid, and depth on the offer.
This is important because it helps make markets more transparent and easier to recognize unfair market manipulations like spoofing and other similar schemes. But more importantly, the DOM data allows traders to see where other players want to deal in the auction. This data was not available in traditional tape reading, as the DOM technology became prevalent in the late 1990s.
Although DOM makes the market more transparent, it still doesn’t show some other important information, such as the historical auction activity, transactional history, and market structure. Moreover, algorithmic activity is very difficult to spot from DOM.
Nonetheless, tape reading is still a great skill to acquire. Mastering tape reading requires familiarity with the way financial markets work, how the various parts interact with each other, what affects the prices of instruments, and many more.
The pros and cons of tape reading
As with almost every technique in trading, there are advantages and disadvantages of tape reading. Let’s take a look at some of them:
The merits of tape reading
The advantages of tape reading include:
- It offers pricing insights: Tape reading can give you an idea of where the market is headed; even a little understanding of tape reading can help you gain some information that can provide a clear representation of the intraday fundamentals, bid/ask imbalances, trading volume, the frequency, and so on. When you learn how to read tape well, you will be able to recognize even small spikes and mounting pricing pressure, as well as be able to make conclusions from the number of orders, canceled right before execution, and their position in relation to the NBBO. You can even trade mean-reversion strategies from tape reading.
- It helps in timing exits when day trading: If you lack experience in day trading, you will struggle with knowing when to close your trades. It is easy to be tempted to stay in a trade for too long just because of your ego, the desire to be right, your overriding emotions, or your inability to withstand the heat of the moment. With the help of tape reading, you can overcome this and make better short-term trading moves. By analyzing the changes in the bid/ask price and the volume, you will be able to arrive at small but valuable signals regarding other market participants’ behavior, spot momentum building up, and make an informed decision on whether to stay or leave the market.
- It is suitable for traders of various experience levels: Of course, tape reading isn’t easy, especially when you consider the process of applying some complex techniques mentioned in this post. But that doesn’t mean it is entirely out of the beginner’s league. In fact, it’s just the opposite; if you are just starting, you can use tape reading to get a better feel of the market you want to trade. However, you need 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. As a beginner, it may be easier to start with low-priced stocks (say $30-50 per share or less) with over $1m daily trading volume. Such instruments are considered most favorable when building your tape reading skills.
Limitations of tape reading
Despite the merits, there are some problems associated with tape reading. These are some of them:
- The tools might be hard to navigate: While the “Time & Sales” and DOM windows are widely used in modern tape reading, the screens might be very hard to keep track of or navigate. In many platforms, they come as separate tools that display rapidly changing numerical figures, which might be difficult to read. In fact, using those tools requires extreme focus and quick decision-making skills. In addition to that, there are no historical representations — both in the long or short timeframes. As a result, you can’t get a complete overview of the order book. So, if you want to look at the past performance to get a better grasp of the order flow, you would have to include a third screen, which may further challenge your focus.
- It requires laser-focus: Over 70% to 80% of the trading is done algorithmically, so price action unfolds rapidly. To be a really good tape reader in today’s market, you must develop the ability to make decisions in an extremely fast-paced environment since the information comes and goes in milliseconds. In fact, some orders can come and go quickly without you being able to even take a glimpse of them. So, if you don’t have the mental focus, you might get distracted and confused by the rapidly changing information. Moreover, you may find it hard to distinguish market manipulation techniques, such as spoofing, order ignition, and so on, from real market events.
- The data are not recorded: Critical information like the liquidity volumes only has a brief use, as it passes through your screen and is never recorded. As a result, you won’t be able to find out how long the liquidity was present, whether it was pulled out intentionally, or transferred to other markets. Thus, to become good at tape reading, you must have 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.
- Tape reading alone is not enough: The truth is that tape reading can’t give you a complete representation of the things that are truly happening on the market, such as market structure and the history of price action. Owing to this, you should always complement tape reading with an integrated market view, other indicators, or traditional fundamental and technical analysis tools.
How to use tape reading in day trading
There are different strategies for using tape reading in trading. However, these are the most common things experienced day traders do with tape reading:
Identifying potential support and resistance levels
Experienced tape readers can identify potential support and resistance levels from DOM, which has the order book information (Level II quotes) — most brokers provide DOM on their trading platforms.
Here’s what they do: they often look for large limit sell/buy orders in the order book of any stock on multiple trading venues.
If there are large buy limit orders at a level below the current price level, then the stock’s price is expected to experience strong support at that level. The opposite is also true: if there are large sell limit orders at a level above the current price, then that level is likely to become a resistance level because of the huge selling pressure the stock will experience there. With this information, they can plan their trades.
Knowing where to enter a trade
By knowing the potential support and resistance levels from DOM, traders can get a sense of whether it is a good idea to trade the particular asset and where the price floor stands. In other words, they can decide whether to place a buy or sell trade based on their analysis of the information from the auction process. In addition, they can estimate the associated risk of trading in any particular direction.
Riding the price wave
From tape reading, you can gauge the momentum in the market so you can ride the price wave if you sense a strong momentum. In fact, your work as a tape trader is to identify high-probability opportunities and build your positions accordingly — 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.
Here’s how you can do that: when the trading day opens, wait for the usual chaos of the first trading hour to settle down. Then look for instruments that start ticking up slightly and pay close attention to their order books; check whether bigger orders are beginning to pop up. If there are big orders, it means that the market has a positive sentiment towards the particular instrument.
The next thing is to check what is happening in the bid and prices — if the ask and the bid prices are 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. You can go long here. Also, make sure you keep an eye on the trading volume, checking whether there is a spike. If that is the case, it further confirms the long move, so you should start adding to your position. It means that the bigger players are also trading in that direction, which will push the price further up.
Avoiding premature exit of a profitable position
Of course, the market doesn’t go continuously in one direction; there will always be pullbacks, sideways movements, trend slow-downs, or even outright reversals. But this doesn’t mean that anytime the market pauses, it’s about to move against your position and you should exit from your position. You need to know when to exit and when to hold on to your position.
Interestingly, tape reading can help you do that. From the order book, you can know whether a move against your position is backed by a huge order flow in that direction or not. For example, if you are long and the price suddenly starts ticking downward, check the sell vs. buy orders in the order book. If there are huge buy orders above your entry level and a few sell orders accompanying the down move, you can hold on to your position. But if the down move is backed by an increase in sell orders at decreasing levels while there are no huge buy orders to stop the price drop above your entry level, it may be wise to exit from the trade.
Tips for mastering tape reading in today’s market
Tape reading can help you stay ahead of the competition, but it requires studying complex data in a fast-paced environment. So, a high level of concentration, the ability to process large amounts of data in real-time, and quick decision-making skills are necessary to master the art. However, these are some tips that can enable you to read the tape like a pro:
- Record your screen: To become a better tape reader, make sure you 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 when next you face a similar situation.
- Use a size filter: In today’s market, tape data move very fast. And sometimes, many of them are for tiny orders. To avoid wasting your energy on tiny orders that can’t move the market, you can filter the minimum and maximum orders to show up on your Level II data window.
- Use day trading tape reading in conjunction with the price action: Combine tape reading with the price structure on the chart. This way, you can get a better picture of the market; this is how professional traders do it.
- Keep a close eye on resistance and support levels: Be mindful of those levels with huge orders that can serve as support or resistance levels. Use such levels for entry or exits when necessary.
- Check for volume spikes: Take note of volume spikes and compare that with what is playing out in the order flow.