Reading the Tape

I have read in many places that learning to read the tape is a very valuable skill when it comes to day trading and can significantly improve performance.  That being said, there are very few good sources of information that provide sound training in order to develop tape reading skills.  I will begin a series of posts exploring tape reading.  As a novice trader, reading the tape is still a mystery to me, but through continuous research and study I am hoping to develop such a valuable skill.  The following post is just my interpretation of what I saw in the tape during trading

The price action from 8/30/2011 had some good examples of how reading the tape could prove useful in timing exits and entries.  IWM had experienced a short run up from 71.90 and started bumping up against resistance at 71.10.  It continued to bump up against 72.10 for about 10 minutes (as shown in the figure below).  Will IWM break out to the upside or breakdown?  All charts are 1 min bars.

Normally, the market depth shows exchange orders with sizes <3000 shares.  Up to this point, the bid and ask volumes had been fairly balanced with prints around 2000-3000 shares.  The price made a run up to 72.13 when sellers came out in force.  The picture below shows that the exchanges were showing shares of 12100, 16940, and 22600 on the ask.  These volumes are well above the usually 3000 shares.  Also, notice how the ask volume is overwhelming the bid volume.  The ask depth at 72.13 is much deeper than the bid depth at 72.12, 72.11, and 72.10.  This is a huge warning sign that 72.13 area is important and a sell off could occur soon if buyers don't come out in force immediately.

The price dipped from 72.13 down to 72.10 when the buyers stepped in.  The price was pushed back up to 72.16 when the sellers came out in force again.  You can see once again on the high share volumes and great depth on the ask.

The price drops from 72.16 to 72.14 and the ask volume increases even more signaling that sellers are in control.

The price quickly begins to drop from 72.14 to 72.05 when the buyers step in and try to rally.  The bid volumes increase to about 10000 shares on a few exchanges and the bid depth is much deeper compared to ask depth.  If sellers do not show up immediately, I would expect the price to increase.

The price begins to slip to 72.02 from the 72.05 level despite the high bid volume and depth which indicates sellers are still showing up in force to burn through the bids.  You can see that the bid depth is still good, but the volumes are decreasing and the price is still slipping indicating sellers are still in control.

The buyers are unable to sustain the bid volumes and the sellers come out in full force overwhelming the buyers, as indicated by the huge volumes on the ask and the poor volume and depth on the bid.  The price should continue to drop from these levels and power through the SMA50(red).

The sellers maintain their control with large ask volumes and depth, pushing the price through the lower level at 71.95 in a breakout to the downside.

Finally buyers show up again around 71.87.  The buyers were able to show sustained strength as show in the bid volumes and depth, stopping the price from falling further below these levels. 

I am sure there are many different interpretations of the tape and this is probably an over simplified case.  It is a good illustration of how reading the tape can tip you off to the markets short term behavior, helping to improve order entry and exit points.  While the behavior of the tape in this post seems simple, it is much different in real time.  In real time, the bid and ask volumes are bouncing back and forth jockeying for control.  You have to pay close attention to the large volumes that post in the level 2 data stream, and the values are continuously changing.  With practice it should become easier.