This is a terrific book on tape reading, a must-read for people wanting to learn tape reading. How I found out about this book is when I read somewhere that Nicolas Darvas re-reads this book every week (and also Gerald Loeb’s Battle for Investment Survival).
It seems that most if not all successful discretionary traders have a strong foundation in tape reading, including Jesse Livermore, Nicolas Darvas, William O’Neil, and many others. To me, it is much better to learn how to read directly from the tape, then to get “second-hand” information through indicators, though the journey might be tougher and it takes longer to hone the skills.
I like the fact that this book not only elaborates on tape reading, but it also writes about what it is that goes on behind the scenes (e.g. accumulation, distribution) that results in what gets printed on the tape. I would recommend that Jesse Livermore’s Reminiscences of a Stock Operator be read first, or in conjunction with this book, as Livermore gives more thorough (and exciting) accounts of how stock prices are manipulated. This knowledge would help in recognising the activity on the tape.
I would also recommend that this book be read at least twice. After the first read, practice applying what you have learnt. After sufficient practice, re-read the book again. I found that I picked up and appreciated more points during my 2nd read.
Overall a great book!
Trade in the Most Active Stocks
- It is said that stocks seldom rise of their own accord, they will sag under their own weight unless they are pushed up. I believe this is true, for it is difficult to understand how any stock can remain active unless there is some motivating power behind it.
- One by one would traders take profits, or sell to get into some other commitment. Dying activity will not attract speculators. it is the persistent buying, and selling, which creates activity and demand. There are doubtless several pools, and many professional operators, all interested at the same time in some of our most active stocks.
- In order to make money from speculation we must trade in the active stocks — those stocks in which the professionals operate. The winning combination for us as traders is a stock in which a pool is active, which has strong sponsorship and support from a bank or banks, and the earnings of which are known to be progressively on the increase. Then, our problem is in the timing of our commitments — when to buy and when to sell.
Read the Tape, Disregard Rumors
- We hear that So-and-So is buying; he may also be selling, through another broker. If he wants us to know that he is buying, we should be chary.
- So, let us disregard hunches and wild conjectures. If he buys and sells, the record of his transactions will be on the tape. We must make our interpretation from the record.
Trading Should Be Confined to Intermediate Trends
- The insiders have the greatest advantage over us in the minor fluctuations.
- It is my opinion that there is little use in trying to make money consistently by trading in and out of stocks hourly, or daily.
- The longer the trend, the more opportunity we have to be right. That is why I urge always that trading be confined to the intermediate trends.
- Trade with the trend of the general market, not against it.
Watch the Market Leader
- Watch the market leader, the bellwether (e.g. Steel in 1930). Pay the same attention to its action that you do to your own stock. The market will follow the market leader when every other stock loses its leadership.
Principles of Tape Reading
Volume is the Most Important
- It is not price action, but volume — the amount of money, the supply and the demand — which best tells the story.
- Our job is to determine the balance of the supply and the demand: whether the demand is greater than the supply, in which case the price advances, of course; or the reverse. The action of the volume tells us of the supply and demand; price merely denotes the value of the volume.
Three Main Types of Volume Activity
- Increasing volume during an advance, with the intervening pauses or setbacks occurring on light volume.
- This is indicative of the underlying demand’s being greater than the supply, and favors a resumption of the advance.
- During an advance, if prices decline on dull volume, it is a favorable signal because there is no heavy supply of stock offered for sale. Hence the Wall Street adage “Never sell a dull market” (intended only for bull markets).
- In the majority of situations, dullness following the rally indicates resumption of the advance.
- Turning points on heavy volume: Increased volume at the top of a rally, or of an advance, lasting for some time, with no appreciable gain in prices — an active churning of stock transactions without progress.
- This is indicative of a turning point.
- Turning points on light volume: A “tired” or struggling advance, when stocks creep upward on light volume and “die” at the top.
- This indicates a lack of demand (few buying orders); and, whereas selling orders likewise are light, this action frequently marks a “rounding-over” turn, which may be followed by increased volume on the down side (when the sellers see that they cannot hope for much higher prices at that time).
- These struggling trends are subject to sudden reversals, particularly when they have endured for several days. Sudden reversals are more frequent than gradual rolling over on light volume.
- The drying up of volume at the top can be indicative of a turn, but occasionally these periods of aimless, quiet fluctuations both up and down result in firm stabilization, and then are followed by further advances. The trader loses little by standing aside until he satisfies himself of the outcome by waiting for the confirmatory action following the dullness.
- A downtrend may turn on lighter volume after a previous more severe decline (with high volume) which cleaned out margin accounts, brokers’ loans, long positions of large interests, etc.
- The same applies for declining markets.
Detecting the Turn of a Trend
- During the turn of the trend, professionals will be bidding up market leaders in order to liquidate other stocks (i.e. maintain the market indices to hide the fact that they are liquidating their stocks).
- The liquidation of other stocks shows up in the fact that majority of stocks would be traded in heavily without gaining or losing ground (i.e. they are starting to turn already). Hence study the action of the second- and third-rate stocks. They may give you early confirmation of the reversal.
- In 1929, the inactive stocks began their decline some weeks ahead of the market leaders (e.g. was a difference of 1.5 months).
Types of Top Action
- Generally market tops are of a “rounding-over” type (taking place over a longer period of time, e.g. months) compared to market bottoms which are sharply defined (taking place over a short period of time, e.g. in days). This is because during a market top, all stocks do not reach their pinnacles at the same time, due to the fact that buying takes place more slowly than panic selling.
- Hence to detect tops, we must watch our individual stocks and not depend upon the general market (as reflected in stock averages) for the signal to sell. Since the “topping” takes place over a longer period of time, looking at the volume of the composite market is often deceiving as the volume is spread over many days so each day will not be marked by conspicuous volume.
- Nonetheless if you see the stock averages struggling to make higher peaks, we then are safe in assuming that the demand is not sufficient to push stocks farther without an intervening reaction. That is the time with to analyze with particular concentration the action of individual stocks.
- Watching the tape (i.e. intraday trading action) allows you to get earlier information on selling pressure which would not at all be apparent if you only looked at the daily charts.
- Markedly increased volume following a run-up in price (i.e. not together at the same time) signifies distribution.
- The public is attracted by price changes, not by volume. Pool managers operate upon this human weakness and engineer rapid run-ups of prices, knowing that thousands of traders and buyers will be attracted by this activity.
- Volume increases tremendously at these points, and newspapers carry front-page stories.
- Pools distribute stocks during the latter part of the way up and part of the way down, after the top has been formed.
- False up moves
- A seller wants to unload at the best price possible.
- He sells a large block under the bid, followed by buying smaller transactions at prices running up above the offered price.
- [my note: need to pay attention to the low of the bar for large volumes, even though the close of the bar would deceptively show a higher close.]
- False down moves
- A buyer wants to accumulate at not too great an advance in price.
- He buys a large block, followed by selling smaller transactions at lower prices in order to make it appear that there is plenty of supply.
Identifying “Good” Buying and Selling
- Buying: Good buying are pool or institutional accumulation that absorb stock which will not be thrown upon the market at the first signs of a rally. Bad buying are purchases made short coverers or scalpers.
- Selling: Important selling are liquidation by pool or institutional accounts, while marginal selling are from overextended trading accounts or public selling from fear.
- The time to look for “good” buying and selling is following either a substantial reaction or a substantial rally. After the turn, the extent and character of the movement tells the tale.
- An exceedingly rapid recovery denotes short-covering, while a more gradual advance with constant volume of transactions, as opposed to spurts and wide price changes, indicates a better quality of buying.
- After the initial rally, watch the secondary reaction, if one occurs. Where the market rallies in points between sales, then you know it is mostly short-covering and that it cannot hold. Do not overstay these sudden rallies (or fast reactions, if you are short); they have a habit of dying out suddenly.
- Margin selling has a swifter pace, and prices drop rapidly between sales. Liquidation is more persistent and broader.
- Groups accumulating stock often buy “on a scale down”, consequently their orders may be noticed on reactions when they are filled quietly at more favorable prices.
- To determine if a rally is due mainly to short-covering or long buyers, look at the rapidity of price changes. Long buyers will not be in a rush to buy and will not buy “at the market”. Short coverers will be placing buy orders “at the market” to quickly get out with their profits.
- When a piece of news breaks, check back quickly over past action: determine whether the stock has been run up actively on increased volume. Big operators know that the time to buy is when the public sells — on bad news — and that the time to sell is when the public buys — on good news.
- If the pool wishes to distribute stock, it must attract a public following; and a following cannot be attracted without increased activity. Rising prices, high volume, judicious doses of propaganda, and the big news event: there is your program for distribution.
- When you decide to sell, sell quickly; do not wait for unnecessary confirmation. If you do, you will lose many dollars of profit. if you are not sure, sell anyway and let the others try for the top.
- The public is usually wrong. When a major news breaks after the close of the market, ask ourselves: “What will the rank and file do in the morning?”. Watch for confirmatory signs where the public’s bet is being proved wrong (e.g. the public sells on bad news but the heavy volume of selling orders are being taken by important buying), that is the time to bet contrary to the public.
Support and Resistances
- Take note of where (i.e. at what price) the volume comes in testing your resistances. Volume indicators on daily charts will be an aid, but they will not show you where or how within the day’s range the volume occurred.
- Congestion levels, where stocks have remained for periods of time, usually resist the move when the stock again approaches them (either on the way up or on the way down).
- Resistance and support levels lose their power in proportion to the time which separates them.
- If a level holds against an assault, and if it breaks after holding for a long time, the plunge may be deeper than if it had given way under the first assault. Whoever was supporting the level has misjudged his ability to withstand the assault and has depleted a large portion of his capital in the unsuccessful attempt.
- An operator may test strength by selling a large block of stock and, if this is readily absorbed, then switch his position and “go long”.
How to Speculate
- Operators must risk fortunes on their judgment of conditions. We, on the other hand, who buy and sell in small lots, must learn to tag along with the insiders while they are accumulating and running up their stocks; but we must get out quickly when they do.
- Practice forecasting future movements from charts of every transaction and then check up to see if you have judged correctly. When you miss, go back over your previous days’ action, and see if the signals were not there but that you misinterpreted them.
- Do not try to watch more than 3-5 stocks. Many successful traders operate in only one stock; but they know that one.
- If you notice action which you do not entirely like, do not hope. Watch, analyze, study! Sell quickly if you think something unexpected has occurred.
- You can buy in again any time, but you cannot bring back profits which have been wiped out by a sudden, unforseen reaction.
- The emphasis in the handling of all commitments should be put on the prevention of large losses and the willingness to accept many small losses.
- Never answer a margin call.
Capitalization and Floating Supply
- The larger the floating quantity of stock, the less will the stock gyrate abnormally. The ideal trading stock is one of which there is a large floating supply, which is being traded in constantly.
- If you want to play small capitalization stock, seek unusual situations, buy them outright and hold on tight for the important move. They swing so widely that it is most difficult to catch the in-between moves.
The Time Element
- It takes time to build a stabilizing price structure (i.e. layers of buy and sell orders that will ‘check’ any rapid price movements) after rapid advances or rapid declines.
- Hence the more time a stock spends in a congestion period — in an area of closely lapped, daily price ranges — the more pronounced will be the trend which follows.
- Human beings need time for the return of reason following shocks.
- Stocks frequently rally in three-day periods, and consequently their market action at the ends of these periods should be more carefully analyzed if you are attempting to catch the active movements of stock prices.
- There are no interests in Wall Street powerful enough to stem the tide of wholesale public liquidation. Powerful interests can only push up large market leaders when the market is technically set for the maneuver.
- You can judge whether your stock is normally or particularly active in comparison with previous days by looking at the total volume at specific points during the day (e.g. 10.30am, 12.10pm, 1.30pm, 2.10pm).
- Think in dollars, quickly calculate transactions in terms of dollars, and you will get a better sense of the action of the volume if you do this.
- Stock Market Theory and Practice (1930), by Richard Schabacker
- A Course in Trading (1933), by A. W. Wetsel (Wetsel Market Bureau)