Tape Reading Trading Strategy Backtest

Tape Reading Trading Strategy – Can It Be Done? Rules And Backtest

With the emergence of personal computers and online trading via electronic communication networks (ECNs), you may think of tape reading as something ancient. While the term brings up memories of trading legends like Jesse Livermore, it is worth noting that, tape reading is still a part of the toolkit of day traders and scalpers in today’s markets. But what is the tape reading trading strategy?

The tape reading trading strategy is a method of trading that is based on studying the market data presented in Level II quotes in the Time and Sales window. In the past, this strategy involved reading old-style ticker tapes transmitted over telegraph lines, which provided traders with market data (ticker symbol, price, and volume) — that’s where it got its name from. The strategy is mostly used by day traders and scalpers to spot and take advantage of short-lived shifts in demand and supply.

In this post, we take a look at the tape reading trading strategy, and we’ll also include a backtest at the end of the article.

Related reading:

What does tape mean in trading?

Tape Reading Decoding Market Sentiment

In trading, tape refers to ticker tape, which describes the paper ribbon used in the late 19th and early 20th centuries for mechanically reporting and disseminating stock quotes and trades, made famous by the Jesse Livermore trading strategy.

Now present as an electronic representation of price quotes that appear in a linear fashion, providing investors with market information, ticker tape first appeared as a component of 19th-century ticker devices, which printed stock symbols and numeric data to convey information about trades and prices via telegraph wire.

The entries on the ticker tape include the stock symbol (which identifies the company whose stock has been traded), volume (the number of shares traded), the price per share at which the trade was executed, an up-or-down triangle indicating whether the price is higher or lower than the closing price of the previous trading day, and a second number indicating how much higher or lower the trade’s price was than the previous closing price.

Today’s electronic ticker tapes are color-coded, with green used to denote greater trade prices, red used to denote lower trading prices, and blue or white used to denote no change. Since 2001, trade prices are displayed in decimals rather than in fractions which were in use before then.

A more advanced form of the ticker tape in today’s market is the time and sales data, which provides a detailed account of a security’s or market’s trading activity. Although using the time and sales data is analogous to reading an old-fashioned ticker tape for an individual stock, the market data is now distributed as a real-time digital display that includes trade volume, price, direction, date, time, and exchange for each trade.

Most trading platforms have a well-labeled time and sales window, displaying real-time market data. The window shows a running table-format tally of trades for shares of a specific stock. Each of the primary components of time and sales, such as date/time, price/change, and volume, is organized in columns.

Rows of data are frequently color-coded to indicate whether the trade occurred on, within, or outside the bid or ask. Many trading platforms now allow investors to customize the display of time and sales data by adding price or volume filters, for example. Here is an example of a level 2 window:

Tape reading strategy

What is tape reading (definition)?

Tape reading is the practice of observing the Level II market data (prices and volumes) in real time to understand the shift in demand and supply and that in making trading decisions. It can help you to gauge overall market sentiment at any moment by monitoring supply and demand imbalances. Contrary to charts and indicators that are based on historical data, tape reading is a leading indicator.

In fact, tape reading is the oldest trading technique used by traders to analyze stock prices and volume. Traders, in the past, got such market data on ticker tapes, which displayed the ticker symbol, price, and volume.

With the rise of personal computers and electronic communication networks (ECNs), market data is now updated through computers, data feeds, and Level II quotes. Experienced short-term traders use such information to improve their trading decisions or even build a complete trading strategy around it.

Real-time tape reading will allow you to see what buyers and sellers are doing. It aids in your understanding of a chart pattern’s action. You can combine tape reading with price action trading and watch how chart patterns develop in real time. This provides a better understanding of the dynamics of supply and demand in a stock.

As an intraday trader, tape reading is a crucial skill to acquire because it enables you to see in real time where there is buying and selling occurring at the level. Acquiring this skill will increase your efficiency, risk/reward ratio, and ability to catch bigger moves while taking on the least amount of danger.

Your ability to interpret tapes is your competitive advantage over many other traders who believe technical analysis is the only thing they need to know. Reading the tape has several benefits, including bringing consistency to your trading, being a leading indicator, allowing you to spot buyers and sellers in real time, reducing trading risk, and putting you in more plays than the charts reveal. Analyzing the bid, offer, size, volume, and prints is the final step in reading the tape. With the right skills, you may be able to predict how a stock is going to move in the short term by reading the tape.

Tape reading was used by the legendary Jesse Livermore to achieve enormous trading success. Livermore started learning tape reading skills in 1891 at the age of 14 while he was working in a bucket shop (retail broker). He would go on to make hundreds of millions of dollars (over a billion dollars) in today’s market with those skills. Sadly, though, he ended his life with a bullet in his head after committing suicide after using too much leverage. He was a boom-and-bust speculator.

Does tape reading still work?

Although tape reading was phased out in the 1960s, it is still being used by today’s electronic traders, especially short-term traders, such as scalpers and day traders. Tape reading provides a lot of information about volume flow in the market, giving a clearer understanding of the market environment and the participants’ behavior. It can give more context about the market especially when it is used in combination with chart analysis. Some scalpers even use it to know when to buy and sell a stock. That said, tape reading is a very difficult art to master. Very few succeed.

Although there is a split between tape readers and chartists — traders who analyze data from the order book and others who look at charts and employ indicators to get trading signals — many traders try to combine both strategies.

The advantage of using tape reading is that it provides you with real-time intraday data that shows demand and supply shifts. This is extremely useful for making short-term price predictions. Tape reading can help improve efficiency when combined with price action trading strategies. It accomplishes this by confirming or rejecting the chart pattern breakouts on an intraday basis. As a result, it can be used to supplement a price action trading strategy.

Many advanced day traders enjoy tape reading because it helps them identify unethical trading practices. Order cancellation, price manipulation, and other techniques are frequently used by high-frequency trading firms, algorithmic traders, and others. Modern tape reading techniques based on an electronic order book make it possible to spot these market manipulations because, apart from the typical information present in the “old-school” ticker tapes, electronic order books also include information on unexecuted orders. Non-executed orders are frequently canceled on purpose, implying that they may be a market manipulation tactic.

Given the enormous amount of information that modern tape reading provides, helping day traders to get a glimpse of the way other market participants feel about particular instruments, showing market manipulation, and allowing for better prediction of prices, it is safe to say that tape reading still works.

Tape reading indicator

A tape reading indicator is a tool that can help display order flow on a trading platform.

For trading platforms that do not come with the time and sales window, such as the MetaTrader 4 platform used for CFD trading, a tape reading indicator can be used to show the real-time order flow in the underlying market. The indicator takes information on real orders on commodities and indexes from the exchange, such as the Chicago Mercantile Exchange (CME), and displays it on the MT4 platform chart. By default, the deals with the main trade contract are displayed with the contract with the highest Open Interest, according to which the forex price is formed.

Also, some platforms that come with an electronic tape window provide some indicators for analyzing market data. For example, the trading and analytical ATAS platform has a large set of unique and useful indicators, such as OI Analyzer, Cluster Search, Imbalances, and Speed of Tape, which can be used to analyze the data from its Smart Tape.

The Speed of Tape indicator, as the name implies, shows the speed of the Smart Tape data and highlights bars in the chart, which had changes in the Tape by the specified criteria.

The indicator calculates the speed by:

  • number of trades
  • volume of trades
  • delta
  • number of buys
  • number of sells

Since time is always calculated in seconds, it means that a trader may use the Speed of Tape to see the highlighted bars, in which the number of trades/delta/volumes exceeded the specified value for a certain number of seconds. One major advantage of the Speed of Tape indicator is that it ‘tracks’ the tape in real time so that a trader doesn’t miss important periods of high activity even if he goes away from the terminal.

What are some popular tape-reading software?

Tape reading software helps a trader “easily” spot the shifts in order flow displayed on the electronic tape or time and sales window. There are many tape-reading software out there, but these are some of the popular ones:

  • Jigsaw: You can simplify your tape reading trading strategy with Jigsaw. It helps you learn faster and trade smarter with simple, repeatable trading methods based on real-world professional Order Flow trading techniques.
  • OrderFlowDashPro/AlphaReveal: This can offer the best insight into the order flow, depth, limit order, and buy and sell program activity possible. If you are attempting to day trade futures with traditional Time & Sales and DOM (or even first-generation order flow software), you stand a better chance with the total illumination AlphaReveal provides.

How to Interpret the Time and Sales Window

Tape reading can be very confusing if you don’t know how to interpret the data. It requires quite a bit of practice to get used to understanding the true meaning behind what you are seeing. Reading the tape is situation-specific, unlike in technical analysis where indicators tell you about oversold or overbought levels. Tape reading is about how a stock is trading on a specific day and at a specific price point. Since every stock is different, tape reading requires you to train your eyes to adapt to the situation of the stock you are trading.

Basically, tape reading involves monitoring both price and volume data in the order flow to spot imbalances in demand and supply. Here are the key things to look for:

  • Order sizes: You can tell if there is conviction behind the price action you are witnessing by looking at the amount of orders that are coming through. You would want to see the balance of order flow tips in the direction you want to trade. This is more of a visual signal that your eye becomes accustomed to recognizing with practice.
  • Order speed: Another important aspect of tape reading is the speed of the orders. The magnitude of the orders typically increases when stocks break through support or resistance levels, and the tape typically begins to accelerate. This shows you that there is interest in the stock at this price, rather than just a few retail traders buying or selling at that point.
  • Order condition: The order condition describes which side of the bid/ask spread the deal was completed on. We want to see lots of orders being filled at the ask price when we go long a stock. In contrast, we want to see orders being filled at bid when we go short. This tells us how eager traders are to buy or sell the stock.

Is price action the same as tape reading?

Some might consider tape reading as simply reading the price action but it is more than that. A skilled tape reader doesn’t just check whether the price is rising or falling, he uses volume information to gauge the strength of that move and can even use volume changes to anticipate imminent price changes. So, tape reading is more of studying the market action, rather than just the price action alone.

However, you don’t buy or short a stock because you see the tape speeding up a bit; you must consider support and resistance levels and also combine the data from the tape with price pattern formations. In that case, it is good to combine what the tape is showing you with what the price action is showing on the chart. With the help of tape reading, you can tell when a breakout from a chart pattern is more likely to work and when it is more likely to be a false breakout.

What is Level 2 in day trading?

For exchange-traded assets, such as stocks, Level II is essentially the order book. Orders are placed through a variety of market makers and other market participants. Level II provides you with a thorough understanding of the pricing action by presenting a ranked list of the best bid and ask prices from each of these participants.

If you are a day trader, knowing exactly who has an interest in a stock can be extremely useful. It can help you to gauge the strength of a price move.

How do I learn to read the tape in trading?

You read the tape by studying the order flow, which includes the limit buy and sell orders coming into the market and the executed orders. The order sizes and the manner in which the orders are taken out can tell you where the momentum lies — with the buyers or the sellers.

If the buyers are dominating, it means there is more demand than supply, so the price is likely to go up. On the other hand, if there is more supply than demand, the price is likely to drop.

How do you analyze ticker tape?

You analyze ticker tape by studying the market data it displays, which includes the stock symbol, volume (the number of shares traded), the price per share at which the trade was executed, and whether it closed higher and by which amount.

Tape reading tips

Here are a few tips:

  • Size filter: In most modern platforms that offer T&S, you can change settings to filter order sizes. Without setting the size to a reasonable amount, the tape will be moving much too fast and will be clogged with tiny orders.
  • Combine with chart pattern setups: It is best to use both tape reading and chart analysis. You can use chart reading to identify setups and tape reading for confirmation and entries/exits.

Tape reading example

Let’s say you are a scalper who is skilled in tape reading, and from a stock’s order book, you notice that there are large limit sell orders at a certain price level. This may indicate that the stock will experience significant resistance at these levels, so you may plan to close your long position at that level and book your profit.

Tape reading strategy backtest

The art of tape reading has changed a lot over the last decade. The New York Stock Exchange specialist system was a haven for tape readers, but the specialist was replaced with market makers, and the market makers are not so easy to read as a specialist. We were partially tape readers ourselves from 2001 until 2009 (on NYSE stocks), but it got increasingly more difficult after 2009.

The reason that a market maker is trickier to read is simple: the electronic order book is another beast and much more difficult to find tradable patterns in compared to a single specialist. As a matter of fact, we believe it’s getting increasingly difficult to do tape reading, and it’s very much a futile exercise. Tape reading is a little bit like scalping – please read our take on scalping:

The chances you’ll make it as a tape reader are slim. Short-term trading is close to a zero-sum game, and thus most lose.

Backtesting a tape reading strategy is very difficult. Not only is it difficult to jot down the specific trading rules and setups, but you also need a lot of good data to backtest on. It takes a lot of time and most likely becomes a waste of time.

We believe you stand a much better chance if you save for the long term or backtest swing trading strategies. For example, we offer plenty of trading strategies that have been live for several years.

To show you one example of such a strategy, we show you the results of strategy #81 which is a seasonal trading strategy for stocks:

Tape reading strategy example

The backtest is performed on S&P 500 (SPY) and the 412 trades return on average 0.75% per trade. The annual return is 10.3% which is better than buy and hold despite being invested just 15% of the time and having a “small” drawdown of 23%!

We believe traders would perform better with such a quantitative trading strategy.

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