Last Tuesday we had a very good discussion with a few of the traders on SMB’s desk about the $50 level in AIG. Some claimed it was a huge level and I argued it was just a soft level. In this article I want to talk about my definitions of a level on different time frames and how this is useful to tape reading.
First, let’s start off by defining a level. A level is a place that provides a terrific opportunity for the disciplined and patient trader. It is a place where the risk to reward ratio is heavily shifted to either the buyers or the sellers.
A level is established by the inability of the buyers or sellers to penetrate through a price. The amount of volume and the number of times tested – without breaking, is what gives its importance. This is particularly true for levels seen in short term charts such as 1-15 min charts.
For longer term time frames I find it easier to judge the importance of a level by the number of times it has been tested. It is a much more difficult task to accurately decipher what the levels are unless the level has been tested a few times. When looking at a daily/weekly chart some look at the closing prices, others look at the high/lows for levels. When there is this much ambiguity in the levels I treat them as soft levels. Meaning, I will put on a trade there if the tape confirms it. And I will not put on the trade if the position would be against the intraday trend.
Those levels that have been tested at least three times (i.e. AIG $13.75 and $39 on a daily chart) or have been established intraday with huge volume I treat them as hard levels. That means I will bid/offer in front of them without hesitation as the stock approaches it.
As a tape reader often we are first to see the level s developing and are able to capitalize on these opportunities. It gives us a chance to be in plays, from excellent prices, that are not seen in charts. We are able to spot trades in which the risk is literally one penny and the reward is 25c, 50c+ and even multiple points in extreme situations. Further, seeing the development of the level also gives us significant confidence to pull the trigger next time the level is tested. Often times I find myself bidding/offering at these levels, getting executed and never seeing the position going against me. Doing this lowers my overall trading risk and helps keep my blood pressure low. Reading the tape around the levels also gives us another big advantage. Namely, knowing and timing when the level will break. It also keeps us from taking unnecessary risk on fake breaks and even profit from them.
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