How Important Is Tape Reading in Modern Markets?

Is Tape Reading Important?

Tape reading is a technique for analyzing the price and trading volume of a stock to forecast future movements. Although originally performed on ticker tape, the technique has since moved to the electronic order book.

Tape readers have an advantage over chartists because they can interpret intraday data in real time, filtering pages of numbers into surprisingly accurate predictions of short-term price movement. This near-legendary market skill has additional perks, allowing proponents to measure participants’ emotional intensity while uncovering the day’s leaders and laggards. Tape reading can add firepower to longer-term market strategies.

The basics of tape reading can be learned in a few minutes, but the practice takes a lifetime to master for three reasons. First, the market is enormously complex, requiring many years of observation to understand how individual parts affect the whole. Second, macro forces that move world markets change over time, with quantitative easing controlling one cycle while a housing bubble keeps markets afloat in another cycle. Third, and most importantly, the market structure has changed dramatically over the years, forcing tape readers to continuously learn new skill sets.

Key Takeaways

• Tape reading is a techique of reading price and order volumes in order to anticipate future price movements of a security.
• Originally used when stock prices were literally communicated on ticker tape, the technique has fallen out of use in the electronic age.
• Tape readers have some advantages over chart reading techniques because they can interpret intraday volume in real time.

Revolution in Market Structure

In the 1990s, 50-cent bid-ask spreads forced tape readers to abandon simple tickers and focus their attention on market depth screens, commonly known as Level II. This practice made money in the first few years because it read supply and demand accurately, showing the standing orders of big players as well as which market makers were in control of the security’s direction in that session.

The SEC‘s pattern day trading rule then came along in 2001, triggering an exodus of capital from equities into CME Globex index futures. In turn, those instruments have taken on enormous power, moving thousands of securities at a time.

Many tape readers abandoned Level II in the next few years, choosing instead to watch index futures for clues on broad equity impulses. Level II lost more adherents in 2007 with the adoption of the SEC’s Regulation NMS, which opened the door to high-frequency trading (HFT) computers, dark pools and other algorithmic code that captures 14% of equity volume in the US markets and 9.1% of European markets according to 2023 paper published by Economic Modelling. Tape readers have adapted well to this electronic environment and now watch a broader array of market inputs than at any time in history.

Heard enough and want to become a skilled tape reader? Here are some tips and techniques to help you get started.

Pre-Market Preparation

Start in the pre-market session, looking at the overnight index futures. Keep a 60-minute, 24-hour S&P 500 index futures chart on your screen at all times, referencing overnight levels during the regular U.S. session. Check out whether that index is leading or lagging the Nasdaq 100 and/or U.S. Treasury bond futures. Nasdaq leadership and lagging bonds point to risk assumption, in which traders want to own more speculative instruments, while S&P 500 leadership and strong bonds suggest risk aversion, often driven by adverse events in other world markets.

Consider the impact of the projected open and how gaps will impact trader psychology. Big gaps have become more common in recent years due to the rise in 24-hour trading, and playing them well requires careful strategies. Get ready by estimating how opening prints will interact with overnight levels. A gap into an overnight high or low suggests range-bound action that may yield a quick reversal, while a gap into levels not traded for days or weeks carries a higher likelihood of trend day action wherein major instruments thrust in a single direction for the most of the session.

Important

The busiest periods of stock trading are the hour immediately after market open and the hour just before market close.

First-Hour Tells

Note the opening prints on the S&P 500, Nasdaq 100 and Russell 2000 futures or underlying exchange-traded funds (ETFs). The relationship between price swings and those levels presents the first tell of the day, with bulls in control above opening prints and bears in control beneath. Mark out the first 5- or 15-minute trading ranges, looking for small sideways patterns that could yield breakouts or breakdowns later in the session. Now, take your first look at the relative strength and weakness, pulling up a list of the most liquid ETF for each major sector. Sort the list by percentage change, exposing the strongest and weakest funds in the first hour. This may also identify rotational strategies that persist for the entire session.

Next, pull up the NYSE and Nasdaq advance/decline and up/down volume indicators. These four data sets yield immensely useful tells on short-term capital flows. The advance-minus-decline variation also carves predictive intraday patterns, often ahead of price, as you can see above when the indicator reversed sharply after a strong January open. This reversal led to a nasty decline that dropped major indices deeply into the red. 

Notice now a Fibonacci grid over the initial plunge predicted the extent of a midday recovery, while swing lows near 1,000 defined support that broke in the last hour.

Now look at VIX, recording observations about the morning tape. First, is it flashing red or green after the first hour, and is that number trending higher or lower? Rising VIX signals conflict or fear that favors lower prices, while dropping VIX reveals a speculative appetite that supports higher prices. Second, track divergences between VIX and index action because they often resolve with capitulative behavior that forces the indicator or index to reverse and follow.

Midday Messages

Track first-hour themes into the lunch hour, watching opening prints and market internals. Be especially vigilant when indices push well beyond prior closing prints and then reverse gears, pushing back in the other direction. Market tells become primary leading indicators at these inflection points, often breaking out or reversing ahead of price. These can be used to build or add to intraday positions, or as exit signals, allowing you to take profits or losses ahead of the crowd that gets trapped by sudden changes in the market tone.

Pay special attention between 11:30 a.m. and noon Eastern time when European markets end their trading days, often forcing U.S. indices through key price levels. With other world markets closed, U.S. afternoons may elicit a second theme of the day, with internals shifting off morning messages, moving into new tells that last into the closing bell. This second wave may require a rework of morning strategies that includes exiting early positions to avoid getting targeted by contrary price action.

Reading the Final Hour

Expect persistent intraday themes to reach their climax in the last hour, especially in the last 15 minutes. Index prices can surge much higher and lower during this period, with institutional capital coming off the sidelines, while algorithms work hard to shake out traders wanting to hold overnight positions. Market internals become your best friends at these critical junctures because they tell you what to expect into the closing bell. Numbers that expand or contract throughout the session predict that contrary strategies will fail, while mediocre numbers suggest a mixed close, with neither bulls nor bears happy about the outcome.

What Is the Difference Between Tape Reading and Technical Analysis?

Tape reading is a crude form of technical analysis that originated at a time when stock prices were communicated by telegraph. Tape readers examined the sizes and price of incoming buy and sell orders to forecast the expected movements of stock prices. The techique has largely been replaced by technical analysis, where traders watch chart patterns and moving averages to interpret how the market is changing.

What Are the Best Times to Trade a Stock?

Historically, the best times of day for stock trading are the hour immediately after the market opens or before it closes, because this is when the largest trades occur. This is also when the market has the largest price swings, and the largest opportunities. However, in practice it is difficult to exploit these patterns effectively once trading spreads and other costs are factored in.

Does Tape Reading Still Work?

While some consider tape reading to be obsolete, there are traders who can use tape reading effectively as part of a larger trading strategy. Modern tape readers may use enhanced computer algorithms to interpret order data. Moreover, unlike traditional technical analysts, tape readers also have access to un-executed orders, allowing further insights into the behavior of other market actors.

The Bottom Line

Tape readers interpret complex background data during the market day to gain a definable trading edge over the competition. Through experience and skill, they react to environmental changes well before price movement awakens the sleeping crowd.