Tape Reading – Using the Classical Tool to Decode the Market

1. Introduction

"Tape Reading" is a classical method that uses to calculate the number of

shares Accumulated or Distributed in a particular stock. It been used as one of
the key tool to measure the "Internal Factor" by the Gurus, such as Jessie
Livermore, Richard Wyckoff, etc... Combined with the "Technical Factor" of the
stocks/market.

The Proposition of how Tape Reading works is that The direction of the long
term trends depends upon the amount of stock owned by and disposition of
the insiders and key investors against the public. As Tape Reading can be use
to deduce the Accumulation and Distribution activities, and even estimate the total
percentage of shares in the insiders and key investors. Therefore it can use to
deduce the price direction and level.

Those who are interested in the original detail of how to do so can find out from
some old classic book, such as "Reminiscences of a Stock Operator -by Edwin
Lefèvre" or "Day Trading Bible - Richard Wyckoff", etc.

2. How does Tape Reading Methodology been Evolved... Volume Based

Indicators
While the "Tape Reading" methodology has be evolved over time and use in
current charting indicators, it basic Proposition for the idea are the same:

A) The manipulators/ insiders must accumulate enough percentage of the shares in

a particular stock before they would mark up the price for distribution.

B) The manipulators/insiders are having more information than the public, and
would act before the public has notice the potential of the movement.

The direct translation of the methodology into the current charting indicator is the
On Balance Volume (OBV).

The OBV calculation is basically adding the day's volume to a running cumulative
total when the security's price closes up, and subtracts the volume when it closes
down.

There are many other variations, such as volume weighted moving average etc...
All are based on the same idea that volume should move first (or to be more exact,
that the accumulation or distribution should start first), before the price would
move strongly.

3. How and why does it loss it effectiveness

For those who are seriously want to find out how effective of those volume based
indicators, it can check it out by doing a throughout back-test of data since the
indicators inception till current date.(Which would not likely possible for
individual to do so). Or to check out the results in some books. "The Encyclopedia
of Technical Market Indicators, by Robert Colby" is one of a good book for doing
so.

It can be seen that all these volume-based indicators were performing wonderfully
well from 60's,70's and all of a sudden, in the 80's, they lost their effectiveness as
an indicator for buy and sell.

This is because there are more and more trading software available together with
the Personal Computers, and computerized trading system for the big institution.

Let me explain...
For those volume based indicator that the public is using, they are mainly using the
daily time-frame. So, the volume based indicator has made an assumption that the
trading price and volume are equally distributed in the whole day of the trade.

For the manipulators who would want to paint a picture of Accumulation, they can
simple sell (distribute) the shares heavily, and just before the market is closing,
they can suddenly buy back a couple of percent of what they had sold and push the
price above yesterday's closing price. By doing so, all the Volume-based
indicators will give false information.

One can simple do an experiment to proof this...

By collecting the one minute OBV, 15 minutes OBV, 60 minutes OBV and Daily
OBV over a period of some time, say for two months. It would notice that there
will be contradiction in the signals by the same indicators itself with different time
frame.

In general, the shorter the time frame, the more accurate it would be. But then the
problem would be that most software are not able to handle years of 1 minutes data
(Unless the user has to write special peace of code to compress the 1 minutes OBV
and load it back to match with the daily price chart.)
4. How to correct these errors and bring back it accuracy

Even so, that is to reduce the time frame down to a minute or second, there is still a
problem with the accuracy in such volume based indicator. As there is one more
factor that need to be consider...

As today, the market is full of trading news in all sort of controlled media...
So, when the manipulators wanted to purchase some particular shares, bad news
would have came out to the public first, so that they can buy all the way down.

For the classical method, all fall in price during the transaction are considered as a
distribution, while all raise in the price are considered as a accumulation. And, in
the Figure 4, it shows a snap shot of the Raw data of a typical transaction. Since
the Bid and Ask are very dynamic, and for some high volume stocks, it can be
transacted a couple or few tens of time within a second.

So, the correct way to calculate the accumulated/distributed volume MUST take
consideration of the Bid and Ask on the transacted price.
If the price is taken place on the Ask, it is a accumulation, and if the price is
taken place on the Bid, it is a distribution.

When one can collect the data as such for a particular share, then... over a long
period of time... he can then decode the INTERNAL CONDITION of the stock.
And, it must use together with others Technical Analysis Tool to get a better
timing.

For those who can understand this, it need no further explanation. So be it.

Bless You.
KH Tang

http://blessedfool.blogspot.com/

Relevant articles:-

http://blessedfool.blogspot.com/search/label/Stock%20Market%20Tool