Reading the Tape with Gman: How to Read the Tape

SMB Gilbert Gman Mendez 250

Gilbert “Gman” Mendez

Intraday trading is about skills development and discipline.  Those who under-perform in our arena often have not fully developed their trading skills.  Too many Intraday Traders think that trading is only about fundamentals, learning technical analysis, and loading up.   The developing intraday trader must also learn how to Read the Tape.   Reading the Tape offers an enormous edge to the intraday trader.

I am the Head Trader at SMB Capital and consistently profitable 80+ percent of all trading days.  Respectfully, how many traders do you know make money 80%+ of the trading days in a month? I know a few, and most of them have something in common: they, like me, have developed tape reading skills.

For this issue I would like to give you a brief introduction to Reading the Tape. I will begin by defining Reading the Tape, what is needed, and how it helps your trading. My intent is to give you a brief description of Reading the Tape, and hopefully get you thinking about developing this important trading skill. So let’s get started.

What is Reading the Tape?

Reading the Tape is an important skill all intraday traders must develop.  Reading the Tape is about taking a look at the market from the most basic perspective: supply and demand.  When you read the tape you are trying to determine whether a stock will go up or down from its present price by looking strictly at the bids, the offers, and the prints.  In essence you are gauging the very short term sentiment in the stock by calculating the order flow.

Reading the Tape helps SMB Traders find the places where the big supply and demand exists in a stock, or important intraday levels.  And then armed with this information we seek to understand the storyline behind the stock to make an educated decision of where the stock ought to go to. Let me give you an example. Take a look at the following 3 minute chart of HGSI.

HGSI

HGSI

A chart/tech trader might conclude that the only trade above is the consolidation play around 22.10, with an upside to $23+.  This is a great trading opportunity but from the chart I cannot judge my level of confidence in the play.  If the stock starts to trade below 22, can I conclude the stock is weak?

Let’s take a look at my view on the stock as a tape reader:  22 ARCA sold about 40k shares in premarket, another seller sold lower at 21.5 (some 50k+ shares) and that lead to a nice down move. Then at 21.23 a buyer emerged and bought about 200k shares. Around 9am the 21.5 seller got printed for 80k shares, the seller lifted and the stock traded higher easily.  Right before the market opened 21.8 bought about 400k shares and dropped. The stock traded down to 21.23 where some 40k shares traded. Not surprisingly the stock drove up on the open with very little selling, even through 21.8.  Finally some sellers appeared near 22.1 and the buyer was happy to accumulate at higher prices without letting the stock drop.

So from reading the tape I had identified 4 different events in the stock that allowed me to conclude the stock could trade higher. By the time I started to see the accumulation in the 22.10 -22.20 area I was not initiating my long but instead was adding huge size to my already existing position. My risk at this point was a few pennies for all of my extra size and my level of confidence in the play was very high.

In this relatively simple example I have just dissected the chart to its bare bones. From all the individual events I was able to understand the story behind the big buyer not being able to fill his order without stepping higher.  If the stock had started to get below 22 and I didn’t see the same buying then I would have concluded that the buyer was finally done with his order. If I saw selling below 22 then I would get short…you get my point. The possibilities are endless.

What Do You Need to Read the Tape?

You need access to the Level II (Level II Box).  See the picture below for an example of my Level II (as seen in LightSpeed, our trading software provider).  In this box you ought to be able to see a few levels of buyers (left side of the box), the sellers (middle of the box) and the time & sales –prints (right side of this box). You need access to the ARCA, NSDQ, BATS, EDGX, FLOW, among other ECNs as well as the market makers (GSCO, MSCO, UBSS, etc).  Not all are required, but obviously being able to see all of them increases your edge.

AMZN

AMZN

How Reading the Tape Helps the Trader

Reading the Tape improves your trading consistency. Remember I am profitable 80+% of my month. In fact my negative days manifest from the costs of trading actively.  It is very rare for me to be gross negative. I really have to be off my game mentally for this to occur. After 4 years of trading, I have only reached my max daily stop loss once.

If you are not yet convinced, think about the example given above. Those events provided 6 excellent trading opportunities and we were able to capture many other plays that were otherwise not easily seen in charts. On average each of those trades offered a 1:8 risk/reward opportunity. Even if the stock was nasty and only 20% of those trades were profitable, we would still have been exceedingly positive. The reality is that when you are in an active In-Play stock your win rate for these trades is more like 60-70%.

Further, as active traders and tape readers we are able to limit our risk during fake breaks and reversals.  We are also able to spot the catalysts for when the stock is ready to make its move and often have a chance to load up with little risk. Think about a breakout play where we are able to spot a huge buyer above an important intraday level holding for size. These are plays where you can comfortably take your biggest size and risk a few pennies with a chance to make 50c+ with a win rate of 60%+.  Now that is a chop!

How to Get Started

There is not much literature out there about Reading the Tape, but we are changing that right here at Wall Street Cheat Sheet. SMB soon will be launching the SMB Reading the Tape training program, which I developed. While the course is structured for you to learn the basics of tape reading in two days, you will still have to put in the hard work to develop this important skill. The good news is that learning this skill takes less time than that of learning to read the charts.  Nonetheless, I hope to continue contributing little pieces on the subject on this bi-weekly column to help you get better over time.

Happy Trading!

SMB TrainingWe are proud to have hand-selected SMB Capital as a partner to offer our audience products and services to become better traders. If you are interested in learning more about SMB Capital’s world-class trader training or trader tools, please click here.