<s> TECHNIQUESOF TAPE READING
Other Books in the Irwin Trader’s Edge SeriesQuantitative Trading Strategies by Lars KestnerTrading Systems and Money Management by Thomas StridsmanUnderstanding Hedged Scale Trading by Thomas McCaffertyTraders Systems That Work by Thomas StridsmanThe Encyclopedia of Trading Strategies by Jeffrey Owen Katz andDonna L. McCormickTechnical Analysis for the Trading Professional by ConstanceBrownAgricultural Futures and Options by Richard DuncanThe Options Edge by William GallacherThe Art of the Trade by R. E. McMaster
TECHNIQUESOF TAPE READING
VADYM GRAIFERCHRISTOPHER SCHUMACHER
McGraw-HillNew York Chicago San FranciscoLisbon London Madrid Mexico CityMilan New Delhi San Juan SeoulSingapore Sydney Toronto
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CONTENTS
ACKNOWLEDGMENTS ixINTRODUCTION xiPART ONEA TRADER’S JOURNEY 1Chapter 1The Beginner: Everyone Starts at the Beginning 3Learning to Walk All Over Again 4A Positive Outcome Can Reinforce a Bad Habit 5Risk Management—Don’t Leave Home without It 8Don’t Blame the Guy behind the Curtain—You Chose This Job 9The Famous Bre-X Scandal 11Listen to the Tape; It Is Never Wrong 12Chapter 2Turnaround: Small and Safe 15Opening a Third Eye 16Confidence Grows from Experience 20The Territory and the Map 24Coming around the Mountain 27Chapter 3The First Profitable Year: Charting Success 29Using a Trading Journal 30Using Your Chart of Your Account 33Imaginary Friends Are Important People Too 36v
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Chapter 4Learning to Trade for a Living 37Learn or You Are Bankrupt 38Keying In on Those around Me 39Not Everyone Gets an A for Effort 40You Decide Your Fate; the Market Doesn’t 42Additional Important Beliefs 43Trading Is Not a Need-to-Know Business 44Making the Odds Even 45Making the Probabilities Work for You 46Taking Stock of It All 47Chapter 5The Trader’s Circle: Bridging the Gap between Art and Science 49Strengthen the Mind as Well as the System 51Finding Out More about Myself 52Getting through the Stages 53The Final Stage 53Completing the Circle 55Discovering the Satisfaction of Teaching 57Reveling in the Triumph of Another Trader 59Rediscovering the Circle 60Chapter 6A Trader’s Edge 63Pros Assess Risk; Amateurs Assess Potential 64You Don’t Have to Be in the Middle of Every Battle 65The Dichotomy of the Guilty 67Finding the Elusive Edge 72Chapter 7A Trader’s Intuition: The Real Art of Trading 75What Is Intuition? 75Be Careful of Intuitive Traps 76Trading Mantras 77Chapter 8Rules for and the Mindset of a Mature Trader: The Dos and Don’ts ofTrading 83
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PART TWOTRADING SYSTEM 87Chapter 9Tape Reading: Revitalization of a Lost Art 89One Size Doesn’t Fit All 89Discovering What Tape Reading Really Is 91Are You the Majority or the Minority? 93Market Irony 94The Accumulation/Distribution Relationship 95Chapter 10The Role of Setups 107Different Methods of Entry 109Chapter 11Stop-Loss Placement and Trailing 115Revisiting Risk Management 116Confidence Levels 121Chapter 12Trading Setups 123Jump-Base–Explosion (JBE) Setup 124Drop-Base–Implosion (DBI) Setup 124Open-High– and Open-Low–Break Setups 130Cup-and-Handle Setup 130Capitulation 130Trader’s Action 135Chapter 13Trading Market Ranges and Miscellaneous Points 137Trading Ranges 137Miscellaneous Points 142
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PART THREEPRACTICAL EXAMPLES 145Example 1: Accumulation and Distribution 146Example 2: Entry on Pullback 151Example 3: Jump-Base–Explosion (JBE) Setup 154Example 4: Capitulation 158Example 5: Capitulation 162Example 6: Drop-Base–Implosion (DBI) Setup 167Example 7: Capitulation and Euphoria 171Example 8: Finding Entries in a Strong Trend 176Example 9: Open-Break Setup 180Example 10: Open-Break Setup 183Example 11: Open-Low–Break Setup 186Example 12: Trading within the Range 189Example 13: Drop-Base–Implosion (DBI) Setup 193Example 14: Stop Loss 196Example 15: Drop-Base–Implosion (DBI) Setup 198Example 16: Jump-Base–Explosion (JBE) Setup 201Example 17: Jump-Base–Explosion (JBE) Setup 204Example 18: Drop-Base–Implosion (DBI) Setup 206Example 19: Trend Continuation 209Example 20: Open-Low Break and Reversal 211Example 21: Drop-Base–Implosion (DBI) Setup 214Example 22: Trailing Stops and Confidence Levels 217Example 23: Jump-Base–Explosion (JBE) Setup 221Example 24: Cup-and-Handle Breakout 223Example 25: Capitulation 226Example 26: Open-Low–Break Setup 229Example 27: Fading Breakout 232Example 28: Short of the Range Resistance 234Example 29: Open-Low–Break Setup 237Example 30: Open-Low–Break Setup 239Example 31: Drop-Base–Implosion (DBI) Setup 241Example 32: Cup-and-Handle Setup 244Example 33: Cup-and-Handle Setup 246
GLOSSARY 249INDEX 251
ACKNOWLEDGMENTS
F
irst and foremost we would like to thank the past and present membersof RealityTrader.com. Without their sincere interest and desire to take thejourney through myth and disinformation to trading the reality of the market, this book would not have been possible.To Steve Demarest, Ross Ditlove, and the entire team of professionals at MBTrading.com, thank-you for providing the best trading servicesthat the industry has to offer. The Navigator is one of the best executiontools available today.We would also like to thank those at TheStreet.com who have provided us with a forum to interact with not only other professionals in ourfield but also with those subscribers who offer their personal insight andviews on a daily basis. Specifically, we would like to thank JamesCramer for his ambition to start such a venture and Dr. Richard MeCallfor his constant encouragement and uncanny insight into today’s changing market.We also owe the greatest debt of gratitude to the many professionalsin the trading industry:Alan Farley, who has the amazing ability to see through the curtains of themarket’s uncertainty. Discussion with you is always a challenge. We continue to appreciate your friendship and conversation.Tony Oz, it’s a real pleasure to continue to see your successes as a trueleader in this industry.Chris Wheeler for your continued friendship and faith in our objectivesand goals for the education of traders.ix
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x
Acknowledgments
Jim Sugarman and Tim Bourquin from the Online TradingExpo.com forhaving the drive and initiative to create a dynamic forum for traders tolearn and exchange educational ideas.Mike Diplock for spending tremendous hours developing and fine-tuningour principles and setups into the RealityTrader Intelliscan MarketScanner.Kenneth Reid for working with us to define the problems and the solutions that plague traders and in the creation of our interactive TradingPsychology CD Series.And finally to the entire staff at RealityTrader.com who burned themidnight oil to make RealityTrader.com what it is today. Thanks to BoYoder and Allen Zuckerman for becoming part of our trading services andhelping us to grow not only as a company but as traders as well; Russ VanDer Biessen for his continued efforts; and Nestor Suarez for his endlessand tireless work ethic. To Jeff Tappan, whose unique marketing insightenabled us to grow our company to what it is today. And to Vic Jung, whois simply the best IT professional and Webmaster on the planet—withoutyou, we would still be dreaming this on paper. Last but not least, a specialthanks to Larisa Bondarenko for everything you have done forRealityTrader to make it a better service. Your wisdom and guidancemade this all possible. You are a true friend.Vadym GraiferChristopher Schumacher
INTRODUCTION
T
his book describes the story of Vadym Graifer, a former Soviet citizenwho was forced to flee developments in Ukraine which jeopardized hiscompany, his life, and his family’s life. The story is a so-called Americansuccess story that has been told time and again about immigrants fleeingreligious, economic, and racial strife in search of a better life for themselves and those around them. Although Vadym is currently a Canadianresident, it’s a story that most everyone can relate to. The personal struggles, journey of self-discovery, and eventual success he attained willreveal many lessons you may have already learned, and, more important,lessons you have yet to realize.Part One of this story deals with these events and the principles thatVadym has come to use every day in his trading. This part also delves intoone of the most important aspects of a trader’s development—the mindset of a successful trader. The principles discussed in these pages willshow you how a totally inexperienced trader went from market illusionsto market reality, from the point of near financial destruction to the freedom of everyday trading life. These principles are ultimately linked to theunderstanding of tape reading described in Part Two of the book. In thissense, tape reading will not be described to you in a manner that themajority of people think this lost art is. It will not be described to you asa verb, in the sense that you are “tape reading.” Rather, after reading PartTwo, you will understand the deeper concepts of how tape reading allowsyou to see and distinguish between the actions of smart money and thepublic mentality. Realizing how accumulation and distribution actionstaken by market participants through movements of price and volume willgive you a strong understanding of an entry and exit strategy for any sysxi
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xii
Introduction
tem or methodology that you currently use. It’s this reality at the root ofprice action that will ultimately lead you to knowing why and how Vadymand those who trade with him use the motto “Trade what you see, not whatyou think.”Part Three presents trading setups and examples taken from tradingexperiences over the past 2 years. Some are presented in fraction form,while others are in decimal form. These setups and examples will ultimately lead you to understand that, while methodologies and systems maycome and go, tape-reading principles will stand the test of time. They havebeen around since the beginning of speculation some 400 years ago andhave been improved over the past 100 years. The principles, therefore, canbe applied to any system currently being used and to any system that maybe invented in the next millennium of speculation.Upon completion of this story, you will fully appreciate the journeyof Vadym Graifer as a trader who was participating in a market aboutwhich he initially knew nothing, in an economy that was different fromthat of his native country, and in an environment that was difficult to function in. It wasn’t his great understanding of company reports, of valuatingnews events, or of how GDP figures govern market movement that madehim successful. It was his rediscovery of the true meaning of tape-readingprinciples that go far beyond what most current presentations offer. It washis movement to an unemotional state of reality and the ultimate truth ofstock movement, the language of price and volume, that turned his trading, his account, and eventually his life into something to be proud of.This is the story of a true reality trader.
PART ONE
A Trader’s Journey
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CHAPTER 1
The BeginnerEveryone Starts at the Beginning
In the late 1980s—early 1990s in the Soviet Union—the birth of a new,rapidly changing economy emerged, a free economy. It started with simple co-ops but quickly expanded to encompass more complex venturessuch as private banks, financial companies, and merchandise exchanges.Although welcomed with open arms by the active part of a society thathad spent 70 years under oppressive rule, it also opened the door to therise of the Russian Mafia. I was a well-educated engineer, and I started myown business in 1987 and developed it into a successful enterprise withover 100 employees.Slowly the dark side of the transition to a free market economysoaked into every facet of business life. As time progressed, the situationbecame less and less stable. Economic links were disappearing, and inflation was climbing at a gallop. Citizens became the target of criminalattacks on a scale that citizens of a civilized country could not imagine.Kidnapping and assassination became the methods of choice to handleeveryday business disputes. The economy and society as a whole began tounravel at an alarming rate.Fearing for the safety of my family, I emigrated to Canada in 1996.This new life had its own set of challenges. Imagine moving to a newcountry and learning a new profession without speaking the language ofthe country. I learned English by watching popular television sitcoms likeMarried with Children. Al Bundy became my excuse for awkward,language-related situations for years to come. At the same time, I set my3
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PART ONE A Trader’s Journey
4
sights on finding and mastering a new profession, day trading. Tradingover the Internet was a logical choice for me, as it allowed me to move atmy own pace unlike other professions that would require well-developedlanguage and communication skills.Although day trading was not yet a buzzword in 1996, it was themajor direction of my quest. The reason I focused on such a short timeframe as intraday trading was because I realized that I lacked knowledgeabout the U.S. economy and couldn’t make much out of company reports.Therefore, I instinctively wanted to exploit the movements that were lessaffected by those factors.As I searched the Internet, I tried to uncover everything that couldhelp me find direction. There weren’t as many Web sites devoted to trading then as we have now, so my education was incredibly superficial.Here’s why.
LEARNING TO WALK ALL OVER AGAINAfter a couple of months, I had an online broker and was armed withquotes and with the Wall Street Journal as my news source. It lookedpretty simple to me. I would find positive information on a stock, buyit, watch it go up, and sell it when it stopped rising. I couldn’t see why itwouldn’t work.Do stocks go up on good news? The answer seemed obvious. Yes.It was supported by comments I read like, “ABCD gained 21/4 points todayon news that the company was granted big new order,” or “XYZ soared 4points after the company announced positive study results in mice.”Did I ask myself some obvious questions like, “If it’s that simple,then what are all those trading books about,” or “Why isn’t everybodydoing it?” Yes, I did. But I also managed to come up with some answersthat supported my confidence. Maybe those books are for professionalswho need to manage millions of dollars and not for small-time traders likeme with a desire to make just a few hundred dollars a day. After muchresearch and preparation, everything was in place, and finally I startedtrading.It was a typical start for someone who commenced trading in a bullmarket. I made money. I always found this to be a fascinating and interesting phenomenon—a novice making money right from the start is acommon occurrence. Maybe, to a degree, it was just beginner’s luck. Butthere are two important factors to consider. First, people are more likelyto start trading during the bull phase of the market’s cycle. Media excitement and the obvious rising of prices attract new traders. This kind of
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market is very forgiving. Selecting a stock is fairly easy, as many stocksgo up with the tide, and, therefore, mistakes might go unpunished. Also,in a bull market, bad timing and missed stops don’t kill as surely as theydo in a bear or a flat market. So it’s just a matter of statistics.The second important factor is that the novice often has no fear. Insome paradoxical way, the state of the mind of the beginner may be veryclose to that of a great professional trader. Of course there is a huge difference in that beginners have no fear because they are unaware of howharsh the outcome of their recklessness can be. The professionals’ lack offear is based on their experience and self-control. New traders have theirhard hits ahead of them, while professionals have left them behind. Laterwe will see how this difference is reflected in different motives for initiating a trade: Professionals take the trade when they are comfortablewith the risk, while amateurs do it when they like the potential profit.Regardless of motives, the state of the mind of amateurs and professionals may be fairly similar. This results in correct action despite the amateurs’ lack of experience and knowledge. However, as we will discoverlater, success without the knowledge of why or how it is achieved onlydelays learning some hard realities and making mistakes, and perhapsexperiencing even total failure.
A POSITIVE OUTCOME CAN REINFORCE A BAD HABITI was not making a killing. But my first experiments confirmed my initialassumption that it was possible to make a living exploiting intraday movements. It was not too hard to get an order filled at that time, even with anonline broker. Competition was not nearly as tough as it was later whentraders discovered more online tools or when crowds started chasing andrunning stocks.During that first period of my trading, I learned one extremelyimportant thing: I saw people arguing about the value of news and aboutthe impact the news had on a stock price. I realized that news has noabsolute value. It became clear to me that people’s perception of the newsis what affects the stock price. This made me uncomfortable, since I hadno tool for reading perception. For a while I was able to calm myself downby thinking that I could foresee how the majority of people would perceive the news. But I soon learned that this was not the case. Stocks werereacting negatively on good earnings because street expectations werehigher. Stocks were reacting negatively even after beating street expectations because whisper numbers were even higher. And stocks would justdrop on good news without the slightest reason that I could see.
6
PART ONE A Trader’s Journey
I saw no consistency to my train of thought, and it shouldn’t havebeen a surprise. At that time my thoughts revolved around the news—getting the best news source, evaluating the news, predicting the newsimpact, and—the killer of killers for a trader—forming opinions based onthe news. Despite my newfound understanding of the relative value ofnews, I continued to make the same assumptions: “Up on good news,down on bad news.” It was a dead end, but I didn’t realize it at the time.I needed a push from the outside to make me overcome this barrier, and,of course, I got one.The market sends us plenty of hints. It’s always talking to us in itsspecific language, sending us messages about what we do right or wrong.We don’t always hear these messages or understand them. And, if wedon’t, the market sends more. Eventually, they become louder. If we stilldon’t hear the message, we don’t change our ways of acting, therebyexposing ourselves to the same danger again and again. Then some of themessages finally come in as thunder, changing our entire lives as traders.For me such a message came in March 1997. The stock was ESOL,Employee Solution. It came down hard from above $30 to under $15.Following the standard beginner’s idea, “If you loved it at $30, then $15must be real value,” I bought 2000 shares overnight. I was totally confident that nothing awful could happen to me based on the “value” of thestock and the fact that the market was definitely bullish at that time.The next morning I saw ESOL open at around $8. What a shock!When I was losing $100 or $200 here and there, I was okay with it. Losingis a necessary part of the game; I already knew that. However, I could nothave imagined taking such a hit on a single trade.My reactions were typical for this situation. The first thing I did wasto ask the opinion of other traders about the stock. This was the wrongthing to do. Sure enough, everyone who got caught in this mess with mesaid something like, “It’s going to be back in no time,” “This is a bearraid,” “Shorts are having their hoopla day, but they will get burned,” andother “useful” things. It all sounded comforting, but the stock was notrebounding as sellers were pounding it even further, both from the distribution side and from the short side. Clearly, value by itself is not a timingmechanism for intraday trading, as value is intrinsic to individuals and isthe basis for speculation, not for timing trades.This was the time to make an important decision. I could stay in apsychologically comfortable zone of denial and do nothing, or I couldadmit the mistake and bite the bullet. The pain of watching each tickbecame unbearable in a few days. I sold the stock as it lost $5, effectivelycutting my trading capital base by over 50 percent. ESOL never
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rebounded and only got lower. It eventually got delisted and is tradingnow on the Bulletin Board at $0.004. Following is an illustration of thisdisastrous trade. (See Figure 1.1.)At this point I was in the first stage of a trader’s development. Myfirst steps were quite typical of a beginner who hadn’t found the rightteachers. First of all, it’s very common for a newcomer to experience akind of euphoria. Everything seems to be too easy, as if money is justwaiting to be picked up. Every new trader who starts by winning experiences this feeling. Eventually, the market punishes such careless attitudesand awakens the trader to the rude reality.In a strange way, this euphoric state of mind is combined with nervousness. Each trade is perceived as the most important one, as a battlethat a trader cannot afford to lose. Therefore, the more significance that isplaced on each separate trade, the more difficult it is to admit defeat.Thisleads to exiting positions at worse price levels than originally intended,which is referred to as a “blown stop” (assuming we are familiar with thevery concept of cutting losses). I perceive my trading today as a whole, as
FIGURE 1.1Graphic illustration of the disastrous ESOL trade. (Used with permission of CBS MarketWatch.)
PART ONE A Trader’s Journey
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a never-ending process in which each separate trade is just a separatetrade, and I measure my success by the favorable ratio of wins to lossesin combination with the reward-to-risk scenarios. This is the correctapproach and eliminates the exaggerated significance of each separatetrade, thus making it natural to take the stop if the trade goes wrong. Nosingle trade is so important that it would be worth tying all my thoughts,time, and money to.Newer traders also tend to view the trade outcome as a reflection ofthe people they are. A loss makes them feel foolish. They feel wrongwhen they take a loss. People don’t like to be wrong. Our desire to be rightcan be stronger than our desire to make money. In trading, this feeling isevidenced by traders who hold a losing position in order to prove that theyare right. Our ego takes over and keeps us from admitting that we made amistake. I see many comments like, “Sellers are wrong. They are beingfooled. They got it wrong.” That is ego talking. Today, I never relate theoutcome of a single trade to who I am. I do not feel foolish when I take apredetermined loss. This trade is not who I am. What is it we really want?To be right or to be profitable?
RISK MANAGEMENT—DON’T LEAVE HOME WITHOUT ITThere is one more important point to cover about the first stage of mytrading career. As a beginner, I didn’t have the slightest idea about riskcontrol and money management. It was not uncommon for me to buy2000 shares of a stock when the total number of daily shares traded forthat stock was only 20,000. I did not understand what liquidity meant,how it impacts risk, and how to measure it. Being from a differentcountry, and never before having dealt with market information, I hada few unexpected blows coming to me. But I never lost the confidencethat I could learn. I was always able to create more options for myselfand was always certain to have them available before I needed to usethem.I had to experience the negative aspects of money management andrisk management in order to create and maintain the right attitude towardprofitability. For example, the number of shares I was going for waslinked to my trading capital. I did not realize that the number of sharesplayed should be linked to acceptable risk. Today I always have my riskdefined, and I trade according to it. If, for instance, risk is defined as a$250 loss per trade and based on the way the stock trade shows that youcan keep a 50 cent stop with confidence, then my share size on this stockis 500 shares. How and where the stop loss should be placed is another
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matter, which I will discuss later by using a few examples I learned laterin my career.
DON’T BLAME THE GUY BEHIND THE CURTAIN—YOU CHOSE THIS JOBThere is another important trait of beginner traders that they should recognize in order to get rid of it. This is that the traders feel that trading is afight. Every day is a battle. Every trade is a battle. Every morning they goto war. If this is a war, then there should be an enemy. The next naturalstep is that traders define their enemies. A list of the traders’ foes willmost likely be familiar to the reader: market makers, specialists, analysts,short sellers, CNBC commentators, and so on. I often see something like:“Market makers run the stock down to shake the traders out and to buystock cheap,” “Darn short sellers killed the move,” and so on.This mindset creates a powerful and extremely harmful concept ofthe so-called them—some unreachable, mighty force that manages all themarket movements and ruins the traders’ brilliant plays. This concept satisfies the traders’ ego while excusing them of responsibility for their ownactions. Unfortunately many self-proclaimed gurus support this approach.It allows them to place the responsibility for their recommendations thatgo badly on some of those traditional enemies. They reinforce this wrongway of thinking in their followers, thus significantly lessening theirchances to learn the game. When your teacher, or the one you trust, sayssomething like, “Their manipulation ruined our play,” it’s time to look foranother teacher.
Let’