Learning Order Flow and Tape Reading

In recent posts, I have highlighted resources that I believe to have worthwhile promise for traders. One area where resources are limited is tape reading: reading the flow of bids and offers into the market to gain a very short-term feel for whether buyers or sellers are dominant.

I mentioned in a recent post that SMB Trading is offering a course on tape reading that is modeled on the training they provide their prop traders. I'm hard pressed to identify any other structured training on this topic.

But suppose you want to do it yourself and learn depth of market patterns on your own? I notice that StockTwits is promoting a NASDAQ Market Replay feature that allows you to replay the bids and offers--and market action--from past trading days. A "lite" version is available free of charge; a version with unlimited replays is $9.99/month.

My sense is that this might make a useful tool for learning by simulation. Through repeated observation, traders could gain a sense for patterns in the order book and call out trade ideas. Traders could also replay periods in the market where their execution was faulty and see how they might have improved by reading the tape better.

Tape reading is not important for all traders. The longer the holding period, the less relevant the tape becomes. A portfolio manager holding positions for days and weeks at a time doesn't need to watch the tape to execute a position a tick or two lower. A high frequency trader at a prop firm, however, may thrive on that execution difference.

As a rule, you will always benefit from focusing on execution at one time frame lower than the one that dictates your holding period. So, for example, if I'm playing a market swing for the morning, I will execute that trade by looking at one- and five-minute readings for NYSE TICK and Market Delta. I will buy TICK and Delta weakness and sell bounces in those.

If, however, the holding period is just a few minutes, you don't want to be working primarily with market orders and giving up an execution edge. Reading the tape is key to getting in and out at good prices. For experienced tape readers, knowing prices where large orders have come into and out of the market can also be useful in market near-term support and resistance.

The NASDAQ Replay capability offers a promising way to gain pattern recognition with fast moving data, given the ability to slow the market down to your settings. It looks like a useful introduction to the challenging world of understanding and trading order flow.
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