Lesson 3 – The Learning Curve

This first lesson is critical in your journey to becoming a Tape Reader. Here, we give you an understanding of the distinct skills needed to read Tape and suggestions on how you go about developing those skills. Note that by Tape Reader, we mean someone that reads the flow of executed trades (Time & Sales) as well as the limit orders on the DOM.

Absorbing the information

There are many skills in life that we consider ‘acquired skills’. These are skills that are gained from experience. Learning to drive is such a skill. When you first get behind the wheel of a car, you are overwhelmed with all of the different things you need to think about all at the same time. Steering, gas, brakes, clutch, rear mirrors, side mirrors, signals – and this is all before you have to even think about interacting with other vehicles in traffic. If you were lucky, your instructor took you to a quiet car-free road for your first lesson. As you practice more, these driving skills become ‘automatic’, you drive ‘without thinking’. On a long journey, some of the driving is beyond your recollection. There is a term called “Highway Hypnosis” used to describe this state. “Highway hypnosis, also popularly known as driving without attention mode (DWAM) or white line fever, is a mental state in which a person can drive a truck or automobile great distances, responding to external events in the expected manner with no recollection of having consciously done so. In this state the driver’s conscious mind is apparently fully focused elsewhere, with seemingly direct processing of the masses of information needed to drive safely. Highway hypnosis is just one manifestation of a relatively commonplace experience, where the conscious and unconscious minds appear to concentrate on different things.” There are two approaches to developing the absorption skill. You could try putting as much information on the screen as possible and stare at it, hoping it sinks in. Another way is to look at a little at a time. Focus initially on certain aspects of the data and then add more once you are comfortable. My experience is that if you take this approach then you will move forward much faster than if you try to absorb everything from the start. Having some form of ‘connection’/commitment to the information will help you to absorb it. If you already trade live, then watch the tape around the time of your setups. Take the setups anyway but focus on the Tape before and after entry. If you only have one setup per day, this isn’t going to work very well. If you are in a trade or close to a setup, this additional feeling of ‘engagement’ will have you focused on what is going on much better than if you just sit down and think “Well, now I have to do my Tape Reading exercises”. Even a SIM account will give you that feeling of engagement to a degree, although a micro account with someone like Oanda trading Forex whilst Tape Reading Forex futures is a much better way to go. You can play with real but small money. There is a huge difference in your focus when you are engaged with the market. Here are some suggestions on what individual components you can focus on.

1. Buying or Selling Activity – When you start, you should not try to focus on the activity of both buyers and sellers. One side is enough. If you are looking at a reversal from a move down, then the activity of the sellers OR buyers could be your main focus. Later, you will be able to watch both sides. Initially your focus should be on absorbing one side.
2. Rhythm – Get into the rhythm of the tape. Summary Tape/Depth&Sales are best for this. Simply watch it and see how it ticks up and down over time. To do this, you need to focus on both the colors of the lines as well as the prices. Focus on just the bid price initially but later expand this so than on ticks down, you are focused on the new bid but ticks up you are focused on the new ask. As much as possible, track where price has been mentally. Don’t worry about the other numbers, just the rhythm.
3. Delta – Delta is something I glance at periodically. It tends to make consistent moves up and down but will occasionally make leaps as momentum changes. When you watch delta keep a mental track on what is normal in terms of moves up and down. Over days, keep track of how high delta tends to go. You might see that on a range day on the ES, +/- 20k delta is normal before a reversal. On the 6E, this number may only be +/- 3k.
4. Size to move through levels – Summary Tape/Depth&Sales shows this. When we tick up, we will see the number of contracts it took to tick up through the inside Ask. If the number of contracts it takes to tick through the ask increases or decreases, it doesn’t necessarily mean that more people are buying at ask. It could mean the behavior of people with limit orders at the Ask are changing. The delta will give you some clues there. Still – don’t try to focus on both sides initially.
5. Small traders versus large traders – I use 2 Reconstructed Tapes to observe this. One for small players, one for large. On the ES, I use a filter of 100 contracts for determining large/small trades and on the 6E I use 10 contracts. On the large side, make sure that as well as the overall picture (red prints vs green prints) you are looking for the different size of traders. On the ES – we may see a lot of 100 lot prints but fewer 500 lot and very few 1200 lot trades. Make sure you can see these prints. Make sure you take note of the time. If there hasn’t been a large print for 3 minutes AND this is an exception for this market. It is significant.
6. Absence of Trades – What you don’t see can be as important as what you do see. If something occurs regularly and then stops, it is important. If you are looking to go long and the sellers disappear, do you really need to wait for buyers to jump in before you trade? Keep this in mind. Similarly, if we come up to a level and no contracts print, we move away and come back to the level and no contracts print again, it is a good sign that no-one is willing to buy there.
7. Size of Depth – Look out for large limit orders, especially as we come to key levels. Watch how buyers react when coming up to a large offer, do they shy away from it? Do they aggressively buy into it? Does the offer shrink? Does the offer grow?

Note that you don’t need to be looking for all of these things all the time. You could specialize in analyzing only one subset of the information and just use that. What is important is that you don’t try to look for everything right from the start. Add in new elements over time. At some point, you will find yourself thinking things like “Boy, buyers are really hitting this hard but getting nowhere” or “This market seems to have died, is there a news announcement soon?” or “delta on the ES is at +100k and it’s only 10am, I’m not fading the highs today” or “There’s a real battle going on at this level”. Now you are Tape Reading!

Interpreting the information

Now that you can actually take the information in, you need to be able to use it to back up your trading decisions. The markets are a four way auction. We have people that are submitting orders ‘At Market’; those that buy at market and those that sell at market. We also have Bids & Offers. These are the people you see lined up on the DOM with limit orders at each level. For a trade to take place, there needs to be both a buyer and a seller. A market buy order is usually filled against someone with a limit order on the inside offer. A market sell order is usually filled against someone with a limit order on the inside bid. Some market participants are getting paid a rebate each time they trade with a limit order, which helps to keep the markets more orderly. For now, just be aware that such people exist and that they may not care about market direction. The four components of the auction are : Market Sellers, Market Buyers, Bidders, Offers. Sometimes these will be the same people. People might be bidding the market whilst at the same time selling. People buying/selling at market can be considered more aggressive but this is not a simple case of “green prints=buy/red prints=sell”.

There can be aggression in the form of Limit Orders too – if somebody sits on a large limit order on the bid, absorbing all selling, this is a very aggressive move. It doesn’t mean the market will reverse each time, but it is aggressive. If you have not done any tape reading before now, you need to ditch any ideas about what you think will see. If you are focused on looking for something specific on the tape, then there is a good chance you will miss what is there. A lot of the things you see are counter-intuitive. Lesson 3 on Summary Tape will go through such a scenario. My recommendation is to put on the Summary Tape/Depth&Sales and replay through your setups. If you have an open mind, you will see the patterns of behavior. Up moves often end with a burst of buying, down moves often end with a burst of selling. Actions should have a reaction. Buying should cause prices to rise. Selling should cause prices to drop. During any move up or down, you should see a mix of green and red prints. If the market is one sided with only buyers on the way up, then be very wary. When you replay the Summary Tape/Depth&Sales you will see certain scenarios replay themselves when the market reverses or continues.

The Reconstructed Tape acts as a final confirmation. If you are about to go long and you see a bunch of 800 lot sell market orders dropped on the market in Reconstructed Tape, wait a second. If the market moves down because of these orders, hold off. On the other hand, if the market fails to move down after a lot of large sell market orders, then you need to get on board long. Not all reversals and continuations are the same though. Still when you focus on a specific market, you will see patterns. At first, you might not be able to explain these patterns to yourself. This is because initially, you may not be considering all four sides of the market. Of course, you can contact us in the chat at the bottom of this page if you want to discuss a scenario you see. Over time, these scenarios will make sense to you because you’ll start thinking in terms of a live auction and real supply/demand dynamics. You will understand why certain moves just run out of momentum and why other moves, although they don’t look as strong, tend to be more sustained.

That’s the end of Lesson 3. Click Here to go back to the lesson plan.

Peter Davies.

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