Reminiscences of a Stock Operator | Ch.1 Pg. 11
Tape reading is not as popular as it was in the old days. Computers have taken care of that.
Savvy traders have adapted and are skillfully implementing tape reading in a much different way today. Chart reading is one method. Another technique is interpreting news and volume traded off the news.
When I say the old days, I am referring to 2007. This is when the NYSE expanded to allow increased amounts of electronic trading. (More on this at the end of the article)
Traders would read the ticker tape (invented by Edward A. Calahan, updated by Thomas Edison) to determine the recent buying and selling pressure. It was much easier to spot a large buyer or seller because daily volume was incredibly light so it was easier to spot a big player. The down side to light volume was liquidity. It could be difficult to exit a trade at a reasonable price.
In the early days there were “bucket shops” to place your trades. I guess you could say they were the first brokerage houses, but without brokers. Prices were posted to a chalkboard as they crossed the ticker tape.
An interesting book to read is Tape Reading and Market Tactics. It is a terrific $7.95 education from 1931. It includes actual numbers and volume from the stock market. A classic trading book to have in your office.
This is how I first came to take an interest in the message of the tape. The fluctuations were from the first associated in my mind with upward or downward movements.
Tape Reading Methods
In this first quote from Reminiscences of a Stock Operator, Jesse Livermore makes note the fluctuations were giving messages. Early on he was intending to understand the message that would result in a trading edge. What tape reading method do you use? I personally use candlesticks in multiple time frames.
“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…”
This is an important quote by Livermore. Too many traders want to know “why” after the fact. Tape readers by the very definition, don’t interpret THE WHY. Tape reading is interpreting price action.
“The reason for what a certain stock does today, may not be known for two or three days, or weeks, or months. But what the dickens does that matter? Your business with the tape is now-not tomorrow. The reason can wait. But you must act instantly or be left. Time and again I have seen this happen…”
To put this quote by Livermore in context for the modern trader, we could call them momentum traders.
“You’ll remember that Hollow Tube went down three points the other day while the rest of the market rallied sharply. On the following Monday you saw that the directors passed the dividend. That was the reason…”
Notice Livermore wasn’t making notes to potentially trade the reason in the future. He didn’t care why.
He was simply reading it and found the reason amusing. Modern tape readers can use the news to trade stocks in play. The correct way to implement this strategy is to use the news as a catalyst to find stocks in play, but…you are ultimately going to trade the price action.
There is a difference between a catalyst and trade management. Struggling traders believe a catalyst or an edge will translate into profitability. Your edge, or any reason to be in a trade, is only the first part of the trading equation. The money is made or lost in trade management.
An amazing educator and trader, Marian Boyle, writes a must-read post each day for the community Good Morning Wall Street. It is a great source to find stocks in play each morning.
“Well, I kept up my little memorandum book perhaps six months. Instead of leaving for home the moment I was through with my work, I’d jot down the figures I wanted and would study the changes, always looking for the repetitions and parallelisms of behavior -learning to read the tape, although I was not aware of it at the time.”
Jesse Livermore made it clear he was keeping a trading journal. He also points out that he stayed late to improve. I can’t tell you how many traders I have witnessed over the years leave when the bell rang at 4pm. It was sad to see. If this is you, you have absolutely no shot at success. I used to joke about a daily fire-drill at 4pm.
Trust me. Those who understood, knew I wasn’t joking. How you spend your spare time will dictate how you spend your future.
How Technology Affected Tape Reading NASDAQ Stocks in 2001
There was giant difference trading a listed stock versus trading a NASDAQ stock at this time. You traded NASDAQ or listed NYSE (or AMEX at that time) but few traders traded both.
There was an edge day trading NASDAQ stocks prior to 2001.
At this point NASDAQ and their market making structure was automated and ECN activity was gathering a large share of activity. Market makers fulfilling order flow for institutions decreased dramatically. The most popular trading style implemented by active traders was all but gone for NASDAQ. Monitoring the bid/ask quotes for size vanished quickly. For those of us trading full-time it was mind boggling.
It was like owning a hamburger restaurant being told chop meat distributors don’t exist anymore.
Reading the tape in NASDAQ stocks relied heavily on whether a stock was “well-bid” or well-offered.” If you went long (bought stock) and Goldman Sachs was quoting a large number of shares to buy on the bid, you felt safe. Your risk in the trade was implied to be manageable because you could “hit the bid” and exit the trade by selling to Goldman. *
If a big market-maker was quoting large size, you had every reason to believe it was a real quote. Essentially you were tape reading by monitoring the size of bid/ask quotes and WHO the quotes belonged to.
I worked for Harvey Houtkin back then. He was not a popular guy but he was usually right and he fought to level the playing field for the retail trader. His ECN (electronic communication network) was a growing force on Wall Street at this time. Many traders like to claim the SOES Bandit title. He was the Father. No one disputes that. (His biggest battle was to get SOES, the small order execution system, implemented for retail traders)
How NASDAQ Traders Read the Tape Prior to 2001
The first part of the trade set up was stalking bid/ask quotes. The second part of a NASDAQ tape reading strategy was following time and sales. This section of a “level 2 box” was where a NASDAQ day trader monitored the actual transactions. You were looking for obvious buying or selling pressure. This was modern day tape reading. Green “prints” represent active buying. Red “prints” are active selling.
“Active” means someone is actively buying or selling advertised shares of stock.
For example” a bid/ask quote of GSCO 2,000 25.25 x MLCO 3,000 25.27 means 2,000 shares are advertised to buy at 25.25 and 3,000 shares to sell are advertised at 25.27. I can advertise to buy at the bid (and hope someone actively sells to me (this would be a red print in time and sales) or I can buy actively from the shares advertised at 25.27 (this would create a green print in time and sales).
In the above example GSCO was a bid (advertisement to buy) by Goldman Sachs and MLCO was an offer to sell advertised by Merrill Lynch.
To complete the strategy of reading the tape for a NASDAQ stock, we would look for a “well bid stock” and “green prints” on the tape (time and sales). As long as active buying was occurring (Large and consistent green prints, I would continue to be a buyer.
When the prints started to look like a Christmas tree ornament (red and green active trades), this mean indecision and it was time to sell.
Technology began to change as did executions. NASDAQ implemented the SELECT-NET system and the tsunami started. Select-net was an active trade you could execute for shares against a market-makers quote. You could buy or sell actively. The problem for traders was a market make could hold your trade 31 seconds before deciding IF they wanted to fill you. It was ludicrous but real.
This began the downfall for NASDAQ market-makers. Additional electronic executions came into play and then decimalization destroyed the spread between the bid/ask price.
The game was over when “super-montage” was introduced and market makers essentially became liable for unlimited shares against their quote. This meant traders (and now computers) could quickly make active trades for unlimited amounts. (Prior to this the market-maker had to physically fill your order)
With this increased risk they started to quote less size, automate updates and use ECN’s more.
Market making for a living was dead. And along with it was old school tape reading methods. (Don’t feel bad for market makers. They made a fortune)
How Technology and Volume Affected Tape Reading NYSE Stocks in 2007
There was an edge day trading NYSE stocks prior to 2007. Tape reading was easier, there was far less electronic trading. The floor of the New York Stock Exchange was dominated by “specialists.”
A specialist is in charge of making a “fair and orderly market.” This meant they were in control of the price action on the NYSE. The floor was a giant community of specialists, floor brokers, clerks and institutional players. A fascinating book written by Charles Gasparino about this history and how the floor operated called King of the Club is a must-read for any student of the stock market.
If you wanted good fills on your price there were two methods to execute a trade.
- Physically speak to a specialist (which meant you needed to be a part of the community)
- Place an order from off the floor using a Super-Dot system.
In scenario #1 the greater the potential order, the better the fills, or at the very least the more attention you received. You see a specialist would make money on this “order flow.” The more shares safely they could match buyers and sellers, the more money they made. This is why they needed to know “what’s behind your first order?”
The more you had to buy or sell the easier their job was. Whoever controlled the order flow controlled the stock. A specialist who worked hard to get you better fills (or as close to VWAP for that day-value weighted average price) would get lots and lots of order flow.
Meanwhile… the retail trader sends orders to the floor and had to wait for a fill.
YES, YES, YES, I know there were order handling rules and “we take care of the public” and all of that stuff. Who would you give priority to? A million shares of order flow or a 100 share order to buy IBM?
Anyway, I am sure you could see the edge reading the tape for a NYSE stock. Follow the specialist!!
From your computer, a trader could see the specialist bids/offers and the price action in time and sales. Trade with the specialist and you were in good shape. To make it even easier there is a “specialist book” you can lease electronically each month to see the shares advertised to buy or sell at levels outside of the inside market (the highest bid and lowest offer).
How cool was that? My friend Rob C. would say the specialist was “stepping up or stepping down his quote.” He made a great living following the specialist. He was trading over a million shares per DAY using this method of tape reading.
Then things changed. More and more money was being earned by executing electronic orders. The exchanges wanted more volume on these risk-free transactions so the powers that be on the NYSE shook up the specialist world by announcing the Hybrid trading system.
Remember how I said your DOT order (direct order turn around,-later super-dot) was physically filled by the specialist? Well not only did they have this privilege but there were rules in place for how many shares you could attempt to buy or sell against a specialist quote.
As things evolved you could execute a trade against a specialist quote with limits. You were able to buy up to 1099 shares, on one side of the market every 30 seconds. So in other words you could not buy, then buy immediately again. You had limits in time and size. Though you could buy, then sell. This is considered different sides of the market.
Well hybrid wiped away 100 years of the specialist privilege in one bold move by the NYSE. The limit rules for electronic executions against a specialist quote were essentially removed. I say essentially because they were expended to 999,999.
The specialist was now exposed to a barrage of executions against a quote and could not possibly handle the flood. The result was never quoting size on the bid/ask (at the inside market). This meant the massive order flow that was “worked” by the specialist, was now traded in 100 share lots over the course of a day, week and months.
The orders are filled electronically. Specialist firms now employ algorithms to make a market and the floor of the NYSE is a ghost town. It’s a place for CNBC to have in the background during a broadcast.
Following the specialist no longer works. Traders like my friend Rob are now swing trading. His edge is gone.
Were market-makers and specialists doing anything “wrong?” I guess that depends on who you ask but they weren’t doing anything illegal. They took advantage of the system in place. As any good capitalist would do.
At one point I had over 25 former NYSE specialists, clerks and brokers trading in my NYC office. The education they gave me on order flow was amazing.
Tape Reading in the Modern Stock Market
Sounds pretty grim doesn’t it?
How in the world does the modern trader read the tape? Great traders adapt. If there is any guarantee in the market, it is change is constant. You adjust or move on.
“I think Linda Rashke said it best: “Modern day tape reading from a computer is determining if price is moving closer to or further away from a significant reference point.”
Form the modern trade this means charts. It can be moving averages, candlesticks, Fibonacci numbers or any other method of monitoring price action.
The method doesn’t matter.
The key is to have a system for determining who is in charge. Can you look at price action and clearly say buyers or sellers are in control of this stock?