Tape reading started in the late 1800s, where traders used a ticker machine that is very similar to the ticker you see scrolling across the bottom of major news and business channels today. Early tape reading involved watching price volume closely, trying to determine which side, the buyers or the sellers, were in control. The same is true for today's tape readers, although most have switched over to a Time & Sales window instead of a ticker. It is the same basic idea, just shown in a different format with more information.
Basically, the tape shows how many lots were filled at a given price and whether they were filled at the bid or the ask for any given market. Now although tape reading is possible on a number of different markets, I have found the e-Mini futures contracts to be superb due to their high liquidity. Every contract on the e-Mini futures trades at a different volume, so to stay consistent, I will be talking specifically about the mini S&P 500.
The Public Vs. The Pros
Volume is the single most important factor when reading the tape. By volume, I am referring to the number of lots being filled. Most of the public traders are entering the market with only one to two lots. Professionals who trade for a living will use anywhere from a few lots to a few hundred lots. Universities, corporations, banks, and other large institutions will trade hundreds and even thousands of lots (please keep in mind we are talking about the mini S&P 500) at a time. The public is made up of all different kinds of traders. Some take the market seriously and use a system or strategy, while a great number of others picture the market as a casino. It is common knowledge that those who trade with these enormous amounts of money are simply not gambling with the market. When they take a position, they do so for a very valid reason. Which group of traders would you trust?.
Interpreting the Tape
It is very difficult to explain the tape without viewing it live. In general, these are the things to look for:
Which side of the market has the most volume?
You must always pay attention to this as it is the most important aspect of tape reading. Throughout the day, keep track of where the big players (100 lots and above) are putting their money. If you look to your Time & Sales window and see nothing but traders buying the market with lots sizes like 238, 120, 120, 495, 644, 80, 310, 176, etc., while there are only a few sellers with lots sizes like 58, 100, 63, you know the short term pressure is on the buy side. The same is true, just reversed, when determining selling pressure.
As price approaches the high or low of the day, does a significant amount of volume enter the market?
For example, you see that price is a few ticks away from the low of the day at 1523.50. All of a sudden, you see a few 400+ lots sell the market at 1523.75, and then a 1,000+ lot sells at 1523.50 and price moves down. Many of the public traders at this point may buy the market, hoping to get a double bottom; by reading the tape, we see that the true intention of the market is to make new lows. If you see a big player buying the high of the day, expect price to make new highs.
In the end, tape reading is more of an art than a science. It is not difficult to learn, but in order to get the feel of it, you should watch it live as much as possible during the normal market hours. The more experience you gain with the tape, the more accurate your calls will be.
I wish you much success in your trading!
Conner Hayes is a full time day trader and developer of the Simple Trend Trading methodology. To learn how he trades the e-Mini S&P 500 futures with a 75% win ratio, please visit Simple Trend Trading