Investopedia defines tape reading as “an old investing technique used to analyze the price and volume of a particular stock in order to execute profitable trades. Tape reading involves evaluating the size of stock orders, order speed, order price, and order condition (at ask, at bid, between ask and bid) to identify trends in trading behavior by insiders, professionals and the general public.” They also claim that “Investors read the tape numbers to create an unemotional analysis and capitalize on the behavior of the market.” I can understand how this definition can be confusing; think of Tape-Reading as a code or language similar to Morse code. A few dashes or dots by themselves mean nothing, but if they are aligned, sent and read properly they reveal a message.
The first lesson I received in trading was tape reading. Studying miles of trade history every night was a common occurrence. Finding up-tick bids, down-tick offers, market shorts and bid and ask sizes was the goal. After months I finally started to understand the language. I could start to see what was going on and who was doing it. Was the specialist making a market, did he gap down a stock and buy? Was there a large short filling the book? Was it a market short or a limit? Are there large bids or offers in the book that I can use as a stop? I realized the language was real and was there for anyone who wanted to learn. I finally understood what famed speculator, Jesse Livermore, meant when he quoted “Remember, go with the flow, bend with the trend, do not sail into a gale, and most of all…don’t argue with the tape!”
The playing field and rules of today’s market however are very different than Mr. Livermore’s time. Technological advances have given the public the ability to trade from their laptops or even their mobile phones. Time of trade executions have gone from thirty minutes to milliseconds. The priceless information of the order flow that before only floor brokers knew can now be seen on any of the hundreds of online trading platforms. The past few decades have seen even more changes. This started with the 1971 introduction of the NASDAQ, followed by the 2007 SEC rule that eliminated the up-tick rule for shorts and most recently the 2009 ARCA/NYSE merger. These events plus the market’s appetite for trading algorithms has led to the steady increase in electronic trading that now dominates the majority of volume every day.
Now when you watch the tape if a million share orders to sell XYZ stock crosses, you might not even know. It could happen in a few milliseconds, among multiple exchanges and trade ten thousand, hundred share prints. Before the onset of the popularity of electronic/algorithmic trading, you could have known if that order was a short or a long seller. If the specialist was willing to buy it or did he drop the bid and place the order on the ask. Was it a market order or a limit and if so what was the limit? The open book and Level 2 is almost impossible to read now as well. Algorithmic trading places and cancels millions of orders a day, in milliseconds! As if they couldn’t confuse you anymore, most of these orders are cancelled!
The market is now a battle between investors and computers. Some may argue that electronic trading has leveled the playing field. The art of tape reading or as some say “not just an art but a born talent”, was an unfair advantage. Many of the tools used by tape readers have shrunk. Many have learned to rely more on technical indicators such as moving averages, RSI, and Bollinger bands. The truth is the risk/return for these traders have increased.
The language of tape reading may not be completely dead, I am sure there are many speculators that are still successfully and fluently speaking it. Maybe they are even adapting it to computer models and algorithms. However, the old techniques of tape reading are as popular as Latin is today, but just like Latin it has formed many of the words we still use.