Learn the tape reading trading strategy used by Jesse Livermore, one of the world's greatest stock traders. If you want to master the art of tape reading trading and use the same tactics that made Jesse Livermore more than $1 billion in today’s money read our guide. We’re going to reveal the wisdom behind stock market tape reading and more.
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The story of how Jesse Livermore became one of the best traders on Wall Street is written in the best-selling book Reminiscences of a Stock Operator by Edwin Lefevre. In fact, Jesse Livermore was the trader who pioneered the tape reading trading strategy.
More, in 1891 at the age of 14, Jesse Livermore started learning tape reading skills while he was working in a bucket shop (retail broker). He was so good at tape reading stocks and subsequently making millions in profits that these bucket shops started to kick him out.
Yes, you read that right, the retail broker hated Jesse Livermore for his ability to successfully read the tape.
If you’re scalping or day trading and even for trend following, you probably need to learn how to read tape trading. These market tactics can be used to fine-tune your entries and better time the market.
Let’s kick things off with a short introduction to what is tape reading, how to read tape trading, and then conclude by teaching you a very useful tape reading trading strategy.
What is Tape Reading?
Tape reading is also known as the “time and sales,” (or Level II) is the oldest trading strategy used to analyze the price and volume of stocks.
See the time and sales window below:
What you see in the above time and sales window are the trades that have been executed. Once a stock trade goes through the time and sales window will show us three things:
- The price at which a transaction went through.
- The trade volume or the size of the transaction.
- And the time of the trade.
Note* The order book is visible for stock, futures, commodities, indices, and everything that is on a stock exchange or futures exchange.
Tape reading allows you to see what is going on behind the price chart. Most traders spend their time studying how to read a price chart and see where the flow of the market is going. However, a chart is only able to show you those prices and trades that have already occurred. In that sense, we’re limited to the information we can get from trading technical analysis.
If you want to get to the roots of why the price is actually moving you need to look at stock market tape reading.
Now, let’s see how to read the tape in trading and highlight how useful it can be.
How to Read Tape while Trading?
Nowadays, due to the rise in technological development, modern tape reading also includes limited orders. These orders are non-executed trades that are resting on the order book. With this comes a deeper level of information on what’s really going on behind the price action strategy.
“Of course there is always a reason for fluctuations, but the tape does not concern itself with the why or wherefore. It doesn’t go into explanations. I didn’t ask the tape why when I was fourteen, and I don’t ask it today at forty…” Jesse Livermore in Reminiscences of a Stock Operator
For example, if you see a big buy resting order at a certain price it can suggest the price may find support and bottom out. Conversely, if you see a large sell order resting on the order book above the current price, it may suggest the price may find a resistance level and sell-off.
Market makers, such as major banks, will often place orders so large that they can actually influence future prices.
Here are a few tips on how to read the tape like a pro:
- Tape reading tip #1: use a size filter. Compared to Livermore’s times, nowadays the tape is moving too fast and it can be filled up with tiny orders. To avoid this we can filter the minimum and maximum orders to show up on the Level II data window.
- Tape reading tip #2: use day trading tape reading in conjunction with the price action. Professional traders only use the tape as a confirmation tool for entries and exits.
We’re going to outline a few reasons why tape reading day trading the market can give you an extra edge.
Why Use Stock Market Tape Reading
Reading the tape can be extremely helpful if you are a day trader looking to catch short-term moves. We can view tape reading as one of the most effective indicators for active day traders.
The second reason you would want to use tape reading is to make a quality risk-reward strategy.
Thirdly, tape reading acts as a trend leading indicator as it shows the transactions of who is buying and who’s selling.
Last but not least, Level II is a window into what the smart money aka the big whales is doing. After all, what is ultimately driving the price is the smart money buying and selling interaction. Retail traders don’t have the buying power to alter the price in any way, shape, or form.
Now, we know that it’s a little bit harder to watch the time and sales window on the Forex market, which is an over-the-counter market. However, not all hope is lost, as you can use the Money Flow Index indicator to depict the interaction between smart money buying and selling on various currency pairs.
We’re going to get right to the heart of the powerful tape reading trading strategy used by the trading legend Jesse Livermore.
Tape Reading Trading Strategy
Now, before we reveal the rules of the tape reading trading strategy, we need to lay down the foundation of reading the tape day trading. For this purpose, we are going to steal Mike Bellafiore's Playbook game.
Mike Bellafiore is the cofounder of SMB Capital, a New York-based proprietary trading firm. Tape reading day trading is a big part of his decision-making process.
According to Mike Bellafiore, this is how to think about reading the tape:
Tape reading traders need to look for certain clues on the buy and sell-side orders. For example, if you want to buy stocks, some of these things need to go through the tape:
- Bids stepping up.
- Most trades happen on the ASK price (traders buying from the sellers).
- Big orders showing on the ASK price.
- Buyers holding the BID.
- Thin on the ASK/Offer (showing supply and demand imbalances).
- ASK to spoof (when a trader puts a large order to sell at a certain price and when it gets close to that price it’s pulled out not hitting the market. It’s a tactic to scare people from buying).
- Lack of downticks.
- Time and Sales accelerating, but the price holds firm.
Note* you can use the same playbook in reverse for selling stocks. Check out our guide on the risk-reward ratio formula.
Now, please note that we’re using the tape only after we have spotted a tradable setup. We want to make sure we have a good risk to reward trading opportunities before we read the tape.
Let’s examine how tape reading contributed to Jesse Livermore’s success story. Jesse Livermore's methods of trading in stocks relied heavily on reading the tape.
However, tape reading was only a part of his overall best trading strategy.
Now you might ask yourself:
“What trading strategy did Jesse Livermore use?”
Livermore only liked trading stocks that are moving in obvious directions. So, in this regard, Livermore was more of a trend follower or swing trader.
So, in order to identify and ride these trends, Livermore used a pivotal point system.
“Whenever I have had the patience to wait for the market to arrive at what I call a Pivotal Point before I started to trade; I have always made money in my operations.” Trading quote from Jesse Livermore
In essence, a pivotal point in Livermore’s strategy was a swing high/low price from where the market rallied or sold off in a strong fashion way.
See the stock chart below:
Now, in the old days of Jesse Livermore, there weren’t day trading stock charts.
This legendary stock trader watched the ticker tape and recorded the stock prices by hand. So, whenever a stock from his Watchlist got near a Pivotal Point he was quick to jump on board.
Luckily for us, we can use the stock charts to pinpoint these pivotal points.
Now, here is the process behind Livermore’s tape reading trading strategy:
Let’s assume the stock price has been trading downwards before rallying and leaving behind a swing low (pivotal point). If this stock price rally can’t be sustained and the stock retreats back to the pivotal point, Jesse Livermore will then use his tape reading skills to execute a trade in that region.
See the stock chart below:
Any notable bullish or bearish trading strategy movement from the pivotal point would constitute a trading opportunity.
Here are Livermore’s stock market tape reading rules:
- Use the tape for a clue of who is in control of the market.
- If the market breaks below the pivotal point by $1 (or $3) go short.
- If the market holds above the pivotal point and rallied by $3, Livermore would have bought the stock.
Another tape reading strategy used by Jesse Livermore was to trade stocks that have broken out from a range trading pattern. Livermore wasn’t an advocate of stock breakout strategy, but he looked for signs that the stock will start developing a new trend in the direction of the breakout.
Some of the tape reading rules used by Jesse Livermore are listed below:
- The breakout should be accompanied by a larger than average volume of trading shares.
- The stock price should continue in the direction of the breakout for several days.
- As the new stock trend matures, you should observe natural reactions (buying pullbacks) that are accompanied by a decrease in trading shares.
- The pullback should last on average 3 days and 3 weeks, after which you should observe an increase in trading shares and price resuming in the direction of the trend.
See the stock chart below:
Final Words – Tape Reading
In summary, if you want to improve your tape reading skills spend as much time possible studying the tape and how the stock price reacts to different scenarios. Don’t get frustrated if it will take you some time to develop the skills to read the tape effectively.
We use stock market tape reading as a confirmation currency trading tool and not as a standalone trading strategy. If you’re a day trader or a scalper, tape reading can provide an extra edge over the trader next to you.
Here is a short recap of Livermore’s tape reading trading strategy:
- Only trade stocks that are near a significant pivotal point.
- Use the tape reading skills to gauge when big orders are entering the market.
- Only trade in the direction of the prevalent trend.
- Have patience and don’t chase the market.
Thank you for reading!
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