Trade Review: Bounce Play on LULU

06/19/2013 6:00 am EST


Michael Bellafiore

Author, One Good Trade: Inside the Highly Competitive World of Proprietary Trading

Reading the tape is an important skill for the intraday trader, says veteran trader Mike Bellafiore of SMB Capital, because it helps you make better risk/reward trading decisions.

I received a question from a newbie trader recently who asked the following: When you watch the tape, what is (are) the question(s) on your mind? What specifically are you watching out for? Most especially when you see big bids thrown left (on the bid) right (on the offer).

Let’s use Thursday’s trading session with LULU as an example of what we watch for when we read the tape. LULU failed twice to hold under 64 the prior trading session after trading down from 82ish. Trend traders wondered if this was the end of the down move. Bounce traders were looking for their setup. Momentum scalpers where looking for areas to spot opportunity.

By reading the tape, we found an important intraday trading level at 64.75. The sellers would not lift this level. Significant volume was done right at this price. When we see significant volume done at the same price, we conclude as short-term traders that when the stock starts to move away from this price, it will have a substantial move. LULU did move from this 64.75, something we forecasted with our reading the tape skills.

While watching the 64.75, I noticed something very significant from the tape. I could not get hit on the bid anywhere from 64.75 to 64.50. If a seller wanted to hit the bids, they could and the programs would try and drop out to the lowest price before 64.50. If I bid at any price above 64.50, an automated trading program would cut me and take the print. I would bid 65.56 and watch the stock print all the way down to 57c. I would bid 61c and watch the stock print on the bid at all prices stopping at 62c or worse yet 61.1c without me getting a single share. This was a signal that a passive buy program was on—and a tremendous signal of strength in LULU. Having trend traded LULU for the previous two days on the short side, I was now very interested to get long if LULU cleared 64.75 for a bounce trade.

LULU finally cleared 64.75, and I got long with many others on the desk. Remember, we had been trend trading LULU to the downside very profitably for the past two trading sessions but now this important signal on the tape made us interested in a bounce long position. Our target was 68-68.50, the most important short-term level during the prior two trading sessions in LULU (it is not a coincidence that LULU found 68 in two trading sessions).

LULU trading very well above this 64.75 with aggressive buying on the offer intraday. But twice I noticed this aggressive buying on the offer dissipate, as you can see on the chart below. This was a signal from reading the tape to lighten up and look to buy lower or exit depending on your trading time frame and target for LULU. I see this as an area to lighten up because my target was not yet reached. I eventually got pretty much flat at 68 during Friday’s open session. LULU was not trading above there and this was near my 68/68.50 target.

Click to Enlarge

Reading the tape is an important skill for the intraday trader. As I write about in my next book The PlayBook, it is not the only variable we use to make trading decisions. It is one of many. But as you can see from this LULU example, it is still a very important skill that can help you make excellent risk/reward trading decisions.

By Mike Bellafiore, Co-Founder, SMB Capital

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