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Learning to read orderflow using the reconstructed tape has helped many users improve their trading entries and exits.
See the video tutorial below and the transcript underneath if you prefer.
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Hello folks, this is Ralph. And today I’m going to be answering one question that I’ve been getting a lot. That is what is the reconstructed tape? What makes it reconstruct? What does that word mean when we’re talking about the tape? So there’s essentially two different concepts that we need to talk about so that you can get a good grasp of what the reconstructed tape is.
The first concept is what is an execution. And then the second one is what occurs when a large market order that is larger than the first limit order that would get filled. What occurs in the exchange mechanically, what actually happens. Okay. And then we can talk about how does the reconstruction cur all right, so let’s go ahead and get started.
So what is an execution? So right now we’re looking at a regular tape. Everyone’s probably pretty familiar with this. You have green Rose and red Rose, and they’re all essentially single executions. I don’t think people really understand what an execution is. I think it gets glassed over and, and people don’t really have a good grasp of what each row really represents.
So. Let’s go ahead and dive into a very simple example. Let’s say this trader Bob, he’s looking to sell passively, right? So if we’re looking at this tape right here, we can just say that Bob is looking to get filled a total of three different contracts at 34 77 in a quarter. And I’m just doing this as an example.
Looking at all these different executions. Okay. And then Alice wants to buy a total of two contracts. So an Alice. Sends a two lot order to the market, right? She’s sending a two lot order to the market and then they exchange is going to match her order with the best offer. In this case, Bob’s three lots that are sitting at the very top of the book.
So now Bob gets filled two out of his three contracts, and now he’s still waiting to get filled on another contract. And now Alice is happily filled her two lots, and then the exchange is done. So what happens here? The exchange now reports to your computer, that there was one execution for two lots. And if we just look at the very bottom row right here, this column is volume.
So somebody in this case, Bob got filled two lots from a market order. The Alice sent it’s a ask trade because it happens on the ask. That’s essentially what happens and then maybe another person comes in another. Alice comes in and buys. Two more lots. So now Bob got filled the rest of his, his contracts.
So now Bob has happily filled in short three lots. Alice number one is filled long with her two lots. So we have the Bob is short three. Alice is long too. And then let’s just make another player called Sam. Sam sent an order for two lots. Two lots to buy to the market in the exchange. It failed. Bob’s.
Last lot. So that means a new execution occurred and then got reported to everyone. So this next row got reported to everyone one lot. And then because Sam wanted to get filled two lots. So he bought two. Then another execution occurred. How can you know that Sam sent a two lots market order when the exchange is only reporting.
Two individual fills. Wouldn’t it be nice to know that Alice sent a market order for two lots, and then later on another trader send another market order for two lots. Instead, what they exchange is reporting to you is a two lot fill a one lot fill and then another lot fill. And essentially that’s the concept that I want to get through to you.
That is what executions are, and that’s how it occurs. You know, essentially the executions are telling you. Which limit orders are getting filled. And we saw that because Bob was first just sitting there waiting for his three lots to get filled. And then part of the order got filled two lots, and then there was one lot left and that one got filled in somebody else’s limit order got filled at 34 77 and a quarter.
So that’s executions. It’s only giving you part of the information that is occurring, right? It’s telling you who got filled versus how large the market order, the fills all of these different limit orders that were sitting on the book, how large is that market order? There’s just no way to really know, based on the information that is being reported by this regular tape.
And now the reconstructed tape, what it does, it grabs that information and presents it into a different way so that you can know that there was a two lot market order. And then another two lot market order. Versus a two lot fail and then another lot fill and then another lot fill. Alright. So hopefully people understand that concept.
The next concept we got to talk about is just what really occurs when a large market order gets sent to the exchange. Right now, we just talked about two different market orders, all the same size, two lots, and two lots. What really occurs when a really large market order goes to the exchange and then goes and gets it executed.
All right. So let’s go over a simple example. So I’ve created a very simple price ladder right here. Round numbers. The best bid is 99. The best offers a hundred, and then you can see how many contracts are at each price level. So very simple stuff. And we’re going to go over very. Simple example, but it is going to sweep a few different levels.
So what is a large market order? Just depends on the market itself for some market. It’s a many, be a hundred lots others. It may be 10 million lots. I have absolutely no idea what you’re trading, but for this very simple example, we’re going to say buyer wants to buy a total of 10 lots. So there we go.
They want to buy 10 lots. They send that order to the exchange and then the exchange says, okay, I need to fill this 10 lot market order with the best offer. And then we go here and there it says, okay, I got four lots at a hundred going to fill those four lots with this 10 lot market order. Now that level is essentially swept and then it moves up to the level above it.
So 101. And then essentially, because we need to fill still six lots out of there, 10 lot market order. It fills six, and then it leaves four lots resting at that price level. We won’t talk about what happens, you know, with the bids moving up and how that all works. That’s just not what this video is about, but essentially what the exchange did with this 10 lot market order is it swept the book over two different prices.
So it got some fills at a hundred and then some fills at 101. And you can do this example for larger orders, right? So you could do 10 lots, 20 a hundred, 500. This scenario is still the same. It’s going to sweep over multiple different prices. And what is the exchange going to report back? To everyone in the world, it’s going to repour all these different individual executions.
And this is, I wanted to go over that concept from the beginning. It’s going over all these different executions and then that’s what you’re seeing on your screen. So you’re seeing. All of these different rows, maybe it’s all these different rows. I have no idea, but you’re, you have no idea if all of these right through here are part of a single market order, or if they’re different ones just by looking at this tape.
So, so the reconstructed tape tells you what the true size or very approximate true size of what the market order would be, so that you get a good idea of where all these different larger players are getting positioned. And you can see when people are getting stopped out all of this different stuff that you can see with the reconstruct tape that you just absolutely cannot see with regular.
So I hope this video was very helpful. There’s a bunch of other concepts that I’d like to go over. You know, I think. One of the things that people get misled by a lot is that they’ll filter their tape like this regular tape. They’ll filter it by only orders or larger than whatever amount they care about 400, 500 a thousand lots.
And they’ll call that tape. They’re large order traits and that’s okay. Greater than all. But I think people don’t really understand. What that means, right. They’ll have a large order tape and then they’ll see one row of 400 lots. Right? So instead of six, it’ll say 400 and they’ll be like, wow, that’s a really large buyer coming into the market.
And sure there is that, but likely that large buyer is not buying just 400 contracts. Exactly. They’re buying 500, 600, maybe a thousand contracts. But for you, it only shows up as a 400 LA Phil because. We already talked about. So hopefully you can get to the answer yourself because there is a large seller on the other side that is looking to get filled 400 lots.
And let that sit in. Right. So if you were one of these people who has a tape like this, who’s configured for large orders. It’s actually giving you only certain information. In fact, you’re probably using it in the wrong way, because for me, it’s more interesting to know that there are passive seller who, a big player just sitting there, hanging out and waiting, trying to, and get filled quietly at a certain price.
Rather than there was a large buyer and those sorts of Phil’s sort of become levels that are interesting. And, you know, we can go and talk about this for another 10 minutes, but I just won’t go over that much. But now that you have this knowledge that we just went over today, hopefully if you’re somebody who has a tape like that, so you can think about it and look at it in a different way.
So I’ll just conclude the video now. I hope that everybody learns something. And if you have more questions, please let me know. It’s kind of a company black subject to, to explain. So I hope this clears things up for people, but if it doesn’t for you, please let me know. I’m happy to remake this video, but at least I hope this was helpful for most people and until next time everyone happy trading!