Reading The Tape And Trading Around Traps

The new year’s market is turning out to be pretty similar to the old year’s market. The bulls are still pushing the market higher while bears are looking for volatility where they can find it. A lot of traders bemoan this lack of friction in the market, but I love the strong growth because it makes researching and recognizing potential trades that much more crucial.

The realization I had was about the huge number of factors at play — in the charts, in the order book, and in the market — that I look to in the moment to determine real opportunities from traps or patterns that are too good to be true. Shorts have to deal with bear traps and squeezes while bulls have to contend with value traps. It’s not fun being on either side when you find a great looking chart only to have it turn sideways on you because of a false start or a lopsided order book. That’s why getting a holistic impression of the market conditions surrounding a given stock will put you miles ahead of most of the other pattern traders out there.

On the technical level, my preferred research approach is reading the tape. I love doing this because it tells you so much about where other traders are positioned from the jump. This is extremely useful because I can get a sense of pattern from charts, but when I study the stock’s liquidity and order book I can piece together how that pattern might break on particular stock. Because the market has been so bullish, many (but not all) of these signals end up working with market gravity in driving prices up.

Take Delta Technology Holdings Ltd DELT, which I found after it jumped on my scanner in premarket on a Chinese blockchain rumor and spiked up 150% in a few minutes. I made good trade that day, and kept it on my list. When it started gapping up the next week, I was pretty aggressive in how I traded it because the short interest was still relatively high, but the  liquidity was pooling up around the $2.50 level. I came out of that in the black because I recognized that the upward pressure on the stock was likely going to squeeze the shorts and reinforce a more narrow range.

Unfortunately, there isn’t a magic bullet to distinguish legitimate potential from something that just looks good. I used a lot of the same logic with DELT as I did with SemiLEDs Corp LEDS, which also carried a lot of short interest  but came out red after a quick reversal. However, that loss made me more aware of these kinds of false starts and helped remain supremely aware of book and market conditions as key tools in avoiding unexpected surprises.

The critical thing is to not sell short the value of getting a logically consistent process together when discovering or following a particular stock. It’s a constant refinement since no two stocks or trading days are the same, but you will start to notice where the trends lie and what separates the breakouts from the fakeouts.

Disclosure: Warrior Trading is an editorial partner of Benzinga.