camron.systems.australia 2006By Alan Farley - Editor and Publisher of HardRightEdge.Com
original title - tape reading - bid and ask
The bid - ask spread reveals underlying supply and demand on the tape.
Interpreting the bid-ask spread requires different skill sets than reading changing prices on "the tape". This poorly understood supply-demand engine compresses and expands constantly, responding to shifting market conditions. But most spread movement reveals nothing more than pure noise and has little directional value. While scalpers can use these frequent choppy periods to grab quick profits, technical traders should stand aside and wait. Directional signals will erupt from the spread regularly and allow them more rewarding entries.
Bid-Ask is a highly efficient market distribution mechanism that presents a constant moving target for traders. There are 6 components to predicting price from the spread: strong ask, neutral ask, weak ask, strong bid, neutral bid and weak bid. Follow "the tape" with a focus on these forces and you'll access excellent short-term momentum data.
When conditions create volatility or imbalance, the spread widens and price tends to surge farther on fewer shares. While this movement can be nerve-wracking, it also provides most of the profit potential the day trader is likely to encounter.
Electronic markets operate differently than the listed exchanges. NASDAQ Level I shows only the best bid/ask underlying their competitive market maker system while Level II lists all the players chasing the inside price. A single specialist and several third party exchanges direct all the action on the NYSE. The size of available shares shown on the tape tends to be accurate on the listed exchanges. But NASDAQ size remains highly deceiving. While the drab 10x10 mystery lots of prior years are gone, both execution and bid/ask displays are marred by exchange rules designed to profit insiders and hurt both investors and traders.
Although the marketplace ultimately decides price direction, specialists and market makers constantly use their inside knowledge to trigger volume and profit their own accounts. Specialists have the "little black book" that shows the location and size of all stop orders. Market makers have a similar advantage with Level III. In the absence of more pressing market conditions, insiders will always push price in the direction they expect the most volume or one that will set up their own accounts for the most gain.
A quiet neutral, neutral-negative bid/ask or high volume, high negative bid/ask can both provide favorable trading environments for the short-term trader ready to go long. In neutral markets, cash waits for opportunity and price can jump quickly when it appears. And wide, highly negative bid/ask spreads in very active markets often signal a short-term bottom and offer quick bounce profits.
Serious traders also watch tick, breadth and index to predict the impact of the tape. Use these measures to locate convergence-divergence with individual price action. For example, index movement provides highly accurate prediction on short-term direction for many individual stocks. Use them to filter entries during corrections and to locate key reversal zones. Avoid long positions when an underlying index violates key support, even when the tape is improving.
By Alan Farley www.thestreet.com
Staring at the tape all day can be painful. Blame computer algorithms and thousands of lemming-like hedge funds. They've taken greed and fear out of the buy-sell equation, using size and speed, pushing the intraday bid-ask in whatever direction they want it to go. Expect more of the same in coming years because profit incentives in this new era of market manipulation are too great. The environment would greatly improve if the SEC prohibited phantom pricing and forced the display of real size. This new computerized market is a double-edged sword for public traders. On one hand, it forces them to ignore support and resistance, focusing instead on the quality of relentless pricing in the intraday market. On the other hand, piggybacking computer algorithms can be a great way to make money. Relentless pricing refers to the signature of computer programs on trend days, when markets fail to turn at natural pivot points that would have triggered reversal activity in prior years. Price channels are the telltale signatures of these lopsided events, usually showing up on the index futures. Characteristically, the only counter-trend movement in these types of sessions happens around the lunch hour and in the final 30 minutes, when a sometimes-violent counter-swing shakes out positions ahead of the close. In between, every wiggle against the trend runs into a synthetic wall of pressure that forces pricing in the other direction.
These trend days post 80:20 down:up volume, or vice versa. Historically, these lopsided readings occurred rarely and usually signaled major reversals. That's no longer true. Since February 2000 most have failed to trigger big market turns. Piggybacking is an effective way to align trading strategies with these relentless computer programs. After identifying their signature early in the session; sell all the rallies or buy all the dips, as the case may be. Assume no reversal will take place that day. These algorithms are easy for most traders to see in action. In fact, I'm amazed that folks still ask me to explain what they look like because their intraday footprint is so heavy it makes the forest shake. Here's a down-and-dirty method to identify active computer programs. Start with a quote screen that includes the index futures (or related ETFs) and a selection of liquid equities across a wide variety of sectors. Add in bid, ask, last price, and price change. Color-code the numbers so the downticks are red and the upticks are greens. Then sit back and watch the first 90 minutes of the new trading day. You'll quickly notice buying and selling waves passing through the majority of instruments. These can be extremely rapid pulses, lasting a few seconds, or stomach churning air pockets that persist for minutes. The main thing that will catch your eye will be lockstep price action between dissimilar stocks and sectors. Exchange-traded funds are primarily responsible for this eye-popping alignment. Through these liquid instruments, algorithms buy or sell huge baskets of equities in microsecond bursts. The lightning-speed activity forces the stocks to get bought or sold. Add in a half-dozen cross-markets, and you have a typical program strategy.
Market-depth (Level II screen), has turned into a blur of rapid pricing, making it nearly useless for analysis of short-term supply and demand. The culprit is SEC Regulation NMS, effective March 5, 2007. The purpose of which was to ensure the best available bid-ask pricing for the public investor. But the law of unintended consequences came into play and destroyed whatever was left of the market's level playing field. All that's left is a violent window into an electronic world that we small-fry are forced to navigate. At-home traders have no choice but to adapt to this computerized marketplace, or they won't survive. This is especially true if technical analysis is the basis for risk-taking, because the eggheads writing these algorithms have deconstructed them. In other words, they see you coming, sucker. Better to swim with the current than fight against it.