The Modern Art of Tape Reading & 6 Favorite Trading Indicators
The Modern Art of Tape Reading & 6 Favorite Trading Indicators
The Old Days
Tape reading, as I define the art form, is the unemotional analysis of the trend of stock valuation culled by the cause of that change in value, the velocity of that change in value, and the intensity of that change in value as these changes relate to the value of the stock and/or stock market.
Tape reading prior to the advent of the modern computer age was done literally by watching the trades posted on a roll of paper known as a ticker tape. The huge technological jump in electronics during the 1960s and 70s allowed for that ticker tape to be posted as the electronic tape we see today on financial television, most times at the bottom of the television screen.
With thousands of stocks trading a billion or so shares every day tape reading in that old fashion way today is impossible to be reported quickly and efficiently. Thus the art of reading (analyzing) the ticker tape analysis has morphed into data mining and analyzing the vast amount of numbers displayed on financial websites such as Yahoo! Finance as well as that shown on financial television.
When I was on the trading floor in the 80s to early 90s we floor traders used what was called a trading monitor in order to read the tape. That monitor was a very large television-like screen on which was listed about 40 stocks in stock symbol form. Only the stock symbols, the last trades and the net changes of those last trades were shown on that monitor. The screen was placed about 10 feet above our pit so anyone could see the screen from the back of the pit. My head was cocked upward most of the day as I intently stared and analyzed what was seen on that big, very important, screen. For me the art of tape reading had morphed into the art of reading a trading monitor without getting a sore neck.
The other large, in size and script, monitors I intently watched, if not much more so, were the dynamically scrolling Wall Street Journal newswire and the Reuters newswire. Very little information presented on both of those news sources slipped past me. When I saw news on these screens that I thought was important enough to be a stock price changer, I would instantly shift my focus to the trading monitor to see if the market agreed with that analysis. Back then a New York minute was in relative time, the same as it is today as per news and the market's reactions to the news. Once news was made public the trader was in the starting gate waiting for any reactions to the news. Options being stocks on steroids, if not leveraged grenades with their pins removed, being at the ready for a possible trade was standard operating procedure (in military terms--S.O.P.). Quick and accurate data analysis created the trader's edge. It is still so today!
Once I began to notice changes in stock prices (in either direction) due to data being analyzed I had to decide if stock market contagion (in either direction) was quickly forthcoming or not. The immediate question begged was to hold current positions and thus continue that risk, or adjust those positions. Hesitating was deadly. Uncertainty due to lack of both preparedness and lack of experience was just as deadly. Proper analysis of the cause of the price changes were quite rewarding. The process remains such today.
Never forget that when trading options the underlying (stock, ETF, volatility etc.) is the cart and the options merely the horse! It is imperative to analyze the underlying first, and then shift the analysis to its options market. Your ability to read the modern tape, using your own effective critical path, will determine your options trading results.
Today we have big computer screens, almost instant access to news, opinions offered by too many, and data offered in volume enough to keep a trader so busy he/she can forget to trade! The edge today relative to what the edge was in the day of ticker tape reading lies in the art of knowing what to read and thus analyze in addition to getting the work done correctly so those conclusions can make you money. Thus you need to have a disciplined approach to the analysis.
Information is only the path to power. It is not the actual power. What is the actual power is the accurate analysis of that information as it relates to stock, bond, and option values. In other words get on the path to GIGO (garbage in, garbage out) and the best you will divine is the right answers to the wrong questions being asked. The modern art of reading the tape begins with knowing: 1) where to look; 2) what to look for; and 3) what to do with that correct analysis.
Key Elements
Other than in the rare times of manic buying or selling of stocks the majority of the market's participants are positioned on the wrong side of the market. If you cannot come to this conclusion and accept it as fact, if not stock market gospel, then we part minds as well as stock market strategy at this point. The stock market will do what it has to do to drive the majority crazy.
Given this contrarian path, the key to ferreting out effective data to read the modern tape begins with stock market sentiment readings. Prior to coming to this conclusion you must also accept as stock market fact the following: the stock market always seeks a balance between what is currently priced into its valuation, as well as what might have to be priced into its valuation. Thus, future value estimations explain why the stock market attempts to see at least six months ahead. I think of the market's desire to be able to see into the future as the market preferring order while rejecting chaos. The more orderly the market perceives things to be both currently and into that six-month future, the more sentiment readings move to the fulcrum point of sentiment's linear formation.
Those who design sentiment readings and follow the dynamics of that data use the terms overbought, oversold and in balance to label stock market sentiment. As an analogy think of a sportscaster who opines on which team in that current game has the momentum. In a similar way stock market sentiment moves along a linear path that equates to a game, the sportscaster expressing his/her professional opinion on which side of the balance/fulcrum the game sentiment lies.
Any form of stock market analysis is an attempt to gain an edge on the majority who are investing or trading their capital. Before determining what might be an edge you must first decide that what is being analyzed is efficacious enough to do the analysis. Here is my list of what I know works for me:
1) The slow stochastic: I use this indicator for daily as well as intra-day market timing. (Yahoo! Finance does an excellent job of explaining how to analyze indicators).
2) The relative strength indicator (RSI).
3) Simple Moving Averages (SMA): If you follow my coiling pattern you know that I use for my SMA's the periods: 10/46/230.
4) S3 Sentiment Indicators [Not Explained Here]
5) The NYSE Short Interest tabulations.
6) The daily New Highs/New Lows ratio.
What I do not reference is the Put/Call Ratio or any other option-related indicators, because I have both the bias and the experience to know that the underlying stock is the cart and the option is the horse. Only if I see an entire options board light up, as almost every call and put in most to all expirations catching fire will, I take the time to examine what might be an edge in the making. What I will be looking for is almost instantaneous chaos relative to option values changing. My thinking then would quickly morph to that of seeing the situation as a valid edge to exploit.
When seeing, and especially hearing via the financial media opine about some July whatever call or put having very unusual volume, I will not waste my time doing the instant homework on that stock. Such an opinion is single factor analysis. An example of single factor analysis would be: you see a particular animal for the very first time, that animal having three legs. To then make the mental leap that this entire genus has three legs is false logic. Using single factor analysis is spurious and erroneous as per the science of applied logic. Do not go that route if you want to find an edge.
Using Stochastics and RSI
See the list of 6 indicators that I know work for me. We begin with the slow stochastic and the RSI (relative strength indicator). The slow stochastic must be confirmed by the RSI. The RSI tends to lead the slow stochastic. Thus look to the RSI and then see if it confirms any cross-over of the fast line over the slow line of the slow stochastic. A non-confirmation of the RSI relative to the slow stochastic is a red flag, a stop sign of sorts that should tell you to halt the study at that time. I use this methodology in both stock price directions. The trigger value for the RSI is the 50 level, the RSI moving up through 50 or turning down through 50. The edge found here is in knowing how these two indicators work in tandem.
Merely knowing the importance of the RSI will keep you from raising the risk probability for any trade. Seeing a slow stochastic cross (the fast line crossing over the slow line) is not a buy or sell signal. In strongly trending bull or bear cycles the slow stochastic might do such crossings more than a few times, yet the stock or index in question does not react to that cross. Those are the times when the RSI did not confirm the cross! Thus the edge found here is in knowing that a trend is still in control until the RSI signals that the trend is in jeopardy of ending.
You will at times find the slow stochastic remaining very strong or very weak for what is felt to be an inordinate amount of time relative to your experience when analyzing a certain stock or index. I refer to such chart patterns as either being that of pressing up, or floundering down. When you encounter such a slow stochastic pattern avoid going counter-trend unless the RSI first turns counter-trend. Trying to predict that counter-trend move any other way is best left alone. Taking the contrary trade to a strong trend is equal in all respects to fighting the tape. You have a big edge in simply knowing not to do that!
I do not use other technical indicators such Money Flow, MACD, ROC, etc. My scrubbed list works for me. I keep technical analysis simple yet effective. I avoid indicators that I think of as being not relative to the way I trade as well as being possibly redundant information that is already priced into the RSI and slow stochastic. In addition the more you analyze the more time is taken up in the endeavor. Thus you might reach the emotional and mental point where you do not take the trade! Falling into that trap is known as paralysis from analysis. Avoiding that potential problem is in itself an edge.
Technical analysis is best considered as being a crude map. Never forget the humorous market adage that Columbus used maps. The edge is found in keeping the technical work simple yet effective. One more edge is having the wisdom and experience to incorporate fundamentals for long-term investing.
Courtesy of Skip Raschke, thestreet.com