Most people who get into trading stocks have found that tape reading is difficult to do and it is very stressful. As a former Wall Street insider there is a secret that most retail traders don’t know.
Don’t trade any stock that has an average volume over one million shares a day!
That is it! That is the big secret most Wall Street insiders use to their advantage. Most retail traders like to trade the stocks that are on the most active lists because they are easy to buy and sell and they have tight spreads. But there is a big problem with most stocks that trade on heavy volume and they are:
- Institutional order from every direction
- Spread traders/hedgers
- Too much information
Institutional Order from Every Direction
Once there are too many institutions involved in trading a stock then that constantly changes the direction of the price. Institutions buy and sell stock for many reasons that don’t have anything to do with the stocks fundamentals. Some examples of reasons institutions buy and sell shares are:
- Investors buying or selling shares in their fund
- Yearly window dressing
- Sector rotations
When you mix all of these large orders together then that creates choppy conditions and that makes reading the tape difficult. The direction of the tape changes back and forth to quickly to feel any behaviors out. Another problem institutions create comes from placing their large orders with order desks. Most order desks “work the order” and that means getting the best price possible. That affects the trader because every time the stock looks like it will go in one direction the order desk steps in and stops that move.
Spread Traders and Hedgers
Spread traders and hedgers are trading to protect another position. The direction typically does not affect them so their decisions are based on spread relationships. One example would be Home Depot Stock verse Lowe’s. If home Depot were up 3 % on the day and Lowes were up only 1% then spread trader might sell Home Depot shares short while buying Lows shares. These types of traders are capitalizing on the spread difference of 2% because they know both these companies stock prices move together and will eventually come back.
Too Much Information
Finally, it is just too much information. As a tape reader you need to be able to remember certain price points and the way the quotes behaved around those prices. For example, if every time a stock gets to the low of the day and a lot of sell orders come in but a ECN just sits there and absorbs all of the selling. In this case you would buy that support unless that ECN moved out of the way and the price broke that low. A good tape reader learns to remember certain price levels and how the order book reacts at those levels. If you are trading a stock that has a lot of volume orders come and go too quickly to remember and read that data.