What Is the Tape Reading Strategy and How to Use It in Trading?

Tape reading is an old trading strategy used by investors in the late 1800-s and early 1900-s to determine the changes in asset supply and demand and decide on the entry and exit trade points. Despite its long history, this technique is still implemented in the modern financial market. However, nowadays it is based on cutting-edge technologies. In this article, we will dive into the concept of tape reading, its history, main features, benefits and drawbacks, and everything else you need to know to efficiently apply it to your trading portfolio.

What is Tape Reading?

Tape reading, also known as “time and sales”, is a trading technique that dates back to the late 1800s. It included a stock ticker symbol, size, price, and time of a trade, and was used by investors to monitor the price and the trading volume of financial assets. The name of this strategy derives from ticker tapes that were used back those days to send trading information over the telegraph lines. Although with the introduction of personal computers and electronic communication traditional tape reading became obsolete in the 1970-s, traders still implement it in modern alteration and with cutting-edge technologies.

Modern tape reading is mostly popular among day traders. This technique helps them analyze intraday asset information in real time, thus developing more accurate predictions for short-term trading strategies. However, experts believe that tape reading could be an efficient tool in long-term strategies as well.

When it comes to the learning curve, it may seem that tape reading is quite a simple technique at the beginning. Nevertheless, to become a professional tape reader, it’s necessary to devote much time and effort to study its distinguishing features, exploring the market forces and components, as well as gaining important trading skills and experience.

Brief History of Tape Reading

The tape reading strategy dates back to 1867. It was created by Edward A. Calahan who was an employee at the American Telegraph Company. Another important checkpoint in the history of this technique relates to 1871 when Thomas Edison created the first stock ticker. Since then, tape reading was gaining immense popularity and became one of the most significant technical analysis instruments of those times. A ticker tape that was used to send information over the telegraph lines included the ticker symbol, the price, and the trading volume of an asset. However, in the 1970-s when the world got familiar with electronic communication networks and personal computers, ticker tapes started to lose momentum and finally became obsolete and useless.

It’s important to note that tape reading didn’t disappear it has evolved and adapted to the current financial market. Many traders continue to use similar strategies that appeared from tape reading but are based on more modern technologies.

How to Read Tape While Trading?

At first glance, tape reading seems quite easy to comprehend. It can be considered as a combination of factors, involving asset price, volume, the bid and offer size, and the bid and offer price. However, it can be very confusing at times. Note that before taking any decisions based on this strategy it’s crucial to have a clear understanding of its features and gain the necessary knowledge to reduce trading risks.

Modern tape readers analyze electronic order books to find out in what direction the asset price is moving. In contrast to ticker tapes, these books also provide information about non-executed trades. This way, investors can have a deeper understanding of the asset price action. For example, if a tape-trader realized a large limit buying orders throughout various exchanges below the established price, it may be a sign that the asset is going to face a strong support level. Thus, investors are likely to enter long trades. Conversely, if there is a big amount of limit short orders, it could indicate that the asset price is likely to experience a strong resistance level.

Here are some other tips to take into consideration when reading the tape:

• Pay attention to order speed. The high speed of orders indicates that there is demand for a particular asset at a specific price level.
• Consider order size and use size filters. The financial market has been developing fast and dynamically. As a result, modern tape comes with a huge number of small orders. To minimize this inconvenience, it’s recommended to use filters to determine the smallest and the biggest orders you are interested in.
• Use tape reading in combination with other technical indicators. Experienced traders implement tape reading along with other technical analysis tools to increase the effectiveness of their trading strategy and take more accurate decisions about entry and exit trade points.

Pros and Cons of Tape Reading

Just as any strategy or technical indicator, tape reading has its merits and drawbacks. Let’s consider the most important ones.

Tape Reading Pros

Tape reading has attracted the attention of many traders due to its considerable benefits. Here are some of them.

Deep insight into price movement

Tape reading strategy provides even inexperienced traders with necessary market information, including bid/ask asset price, trading volume, speed, frequency of trades, etc. Professional tape-readers, due to their experience and skills, could dive deeper into price action and base their trading decisions on the number of non-executed orders, pricing pressure, and other factors.

Real-time data

In contrast to charts, which are usually based on historic events, tape reading provides investors with real-time intraday market information, thus, allowing them to take more accurate trading decisions, especially for short-term strategies.

Helps to determine exit trade points

Traders who lack experience often can’t decide when it’s time to exit the trade. As a result, they keep the position until the last moment or close it too early under emotional pressure. Tape reading provides investors with clear signals about the market situation and other participants’ behavior, so they could decide more effectively whether to close the position or keep it open.

Suitable for both newbies and seasoned investors

Although professional tape reading requires much knowledge, beginners can make use of its basic functionality while gaining the necessary experience. It’s recommended to start with one financial instrument and give preference to low-priced assets.

Tape Reading Cons

To effectively apply tape reading to your investment portfolio and limit substantial losses, it’s important to be aware not only of the advantages of this trading technique but also of its limitations. Here are the ones to keep in mind.

Steep learning curve

As mentioned above, tape reading at a basic level is not complicated, and thus is suitable for beginner traders. However, to become a professional tape reader, one should spend much time exploring the peculiarities of this strategy, be capable of analyzing and interpreting market conditions, and more.

Challenging navigation

It could be complicated to keep track of rapidly changing market information on several tape reading screens. Thus, investors have to stay constantly focused and be ready to take fast but meaningful trading decisions.

Inefficient if used isolated

Tape reading doesn’t provide investors with a complete market picture. It doesn’t give enough information about market structure, its components, liquidity, volatility, etc. Thus, this indicator can be extremely risky and may involve a high possibility of loss when used in isolation. As such investors are advised to combine this strategy with technical indicators and fundamental analysis tools as well as continuously improve their trading knowledge and skills.

Tape Reading Trading Strategies

The tape reading technique may help investors in many different ways. Here are some of the common strategies to be aware of.

Identify Support and Resistance Levels

To determine the levels of support and resistance, tape readers analyze order books, the major indicator of the tape reading strategy. For example, if a trader noticed that there are many large limit sell orders on the book, he may expect the asset price to reach a significant resistance level. Otherwise, if he spotted large limit buy orders across various exchanges, the asset price is likely to face a strong support level.

Tape traders who follow this strategy examine the books, find support and resistance levels, and then trade between them. However, once you decided to use this technique, don’t forget to set a stop loss since there is always a possibility that an asset price will break out.

Price Action Strategy

This is another widespread technique that requires the use of technical indicators and fundamental analysis in conjunction with tape reading. For example, if the market has experienced the golden cross and, according to a momentum technical indicator (for instance, RSI), the stock price is expected to increase in value, before opening a long position investors could confirm these signals by tape reading. In case order books show that the asset price is approaching the support level, the possibility of buying trade success significantly increases.

Determining Exit Trade Points

Many inexperienced traders suffer losses since they keep their positions too long or exit them too early under emotional pressure. Tape reading helps investors to overcome this pitfall by providing them with numerous small details about the market situation.

Let’s consider an example. A trader wants to sell his stock. However, suddenly the stock price rises, which results in the trader’s uncertainty about further moves. In this situation, he can turn to the tapes and analyze if the spike was caused by the trade with a big amount of shares or just a few of them. An experienced tape trader knows that an uptrend price movement, as well as a bearish trend, should be supported by a significant trading volume, otherwise it will not last long.

Ride the Wave

Tape reading allows investors to take advantage of the market sentiment. It’s not always necessary to do everything by yourself to identify an attractive market opportunity and develop your position, the most important thing is to be focused on the details provided by this strategy.

One of the important tips is not to be in a hurry and let the market calm down at the beginning of the trading session. Once the chaos starts to settle, it’s recommended to start analyzing the books to spot any large orders. If there start to appear orders with more than 500 stocks or other assets, this could indicate that the market participants have a positive sentiment toward this financial instrument. As soon as the potential instrument is found, it’s necessary to pay attention to ask/bid prices. If they increase in value, it means that bullish traders are ready to pay more while bearish investors want to receive more having acknowledged the potential of this instrument. This is the time to enter the trade. The market and big players may help to carry your position further.

Range Trading Pattern

This tape reading strategy was introduced by Jesse Livermore, who was looking for stocks that broke out of the trading range. Once you decide to follow this strategy, it’s necessary to pay attention to some aspects:

• After experiencing the breakout, the asset price should continue moving in the same direction for at least some days.
• The trading volume during the breakout should be more than average.
• A new trend should be accompanied by pullbacks, which usually last 3 days and 3 weeks. Moreover, at this step, it’s possible to notice the drop in trading assets.
• The period of pullbacks is followed by an increase in trading assets and the price turning back to the direction of the trend.

The Bottom Line

Tape reading is a trading strategy with deep roots. Despite being introduced in the late 1800-s, it has adapted to the modern financial market, and thus, continues to attract the attention of many traders. Nowadays, tape reading helps investors determine support and resistance levels, find out the most suitable time to enter or exit the trade as well as confirm market data received from various technical indicators, charts, and patterns. This technique can be implemented by both beginner and experienced traders. While the former will be able to gain necessary trading skills using the basics of this strategy, the latter can improve their decision-making process by diving deeper into interpreting tape reading signals.

It’s important to underline that to increase their potential profits tape readers need to be patient, stay constantly focused and combine tape reading with other technical and fundamental tools.