CMT level 3 | updated questions and answers

CMT level 3 | updated questions and answers A strong open followed by strong close will allow trader to do what? - Buy on a pullback after next open. A weak close after strong open will allow trader to do what? - Sell short near following open Highs and lows occur where during the day? - Most often at the open Large opening gaps imply what about the day? - Greater volatility Pivot point calculation - P = (H+L+C)/3 R1 = 2P -L S1 = 2P -H R2 = (P -S1)+R1 S2 = P -(R1-S1) Weaknesses of Candlestick charting - 1. Majority of patterns are reversal patterns and require a trade against the trend. 2. Can't determine whether high or low was created first. What is a high wave candle and its significance? - Candle with long uppe r and lower shadows and small real body. When appears in a trend then shows that the market is uncertain about current trend and may soon reverse. Same for doji's and spinning tops. 4 Events that diminish candles effectiveness - 1. Trend slowing 2. Price s converging 3. Rising candles with successively lower closes. 4. Falling candles with successively higher closes. Advance block candlestick pattern - Bearish reversal pattern 3 white candles with progressively smaller real bodies and longer upper shadow s indicating buying power is weakening. Confirmation when close is below midpoint of first candle. Counterattack pattern - Reversal Candle pattern where two candles have opposite color real bodies and the same close. Separating lines pattern - Continua tion pattern where two candles have opposite color real bodies and the same open. Upside Tasuki Gap - A continuation pattern with a long white body followed by another white body that has gapped above the first one. The third day is black and opens withi n the body of the second day, then closes in the gap between the first two days, but does not close the gap. Buy trigger is at the high of the second candle shadow. Stop loss at the low of the window; high of first candle. 3 steps added to trading plan to limit major disadvantage of trend following system - 1. reduce size or not trade during trendless period (employ trending indicator to determine) 2. reduce trading or stop after equity curve declines by pre -defined amount. 3. reduce or stop trading after equity curve entered pre -defined downtrend. 3 major disadvantages of trend following systems - 1. Series of small losses that add up to a large drawdown in trendless market. (biggest issue) 2. Subject to whipsaws 3. Causes extreme volatility in equity c urve How is total risk of a system measured? - Standard deviation of returns How is systematic risk of system measured? - By the beta coefficient of the stocks. 3 conditions that must be met for group think to be useful - 1. people must be unaffected by others decisions. 2. probability of being correct must be independent of probability of everyone else being correct. 3. people must be unaffected by their vote being decisive. Monte Carlo Simulation description - method that creates a sampling distri bution from an original sample by randomly resampling and creating an equity curve. process repeated thousands of times and if majority of equity curves are profitable then it's likely that the system is robust and will be profitable. 2 reasons why Gold ha s inverse relationship with USD. - 1. Hedge vs. inflation 2. Safe haven for weak $ and financial crisis. Rule of thumb about size of st. deviation vs. monthly returns - St. deviation should not be more than 5x the monthly return. Total risk formulas - TR = market risk + firm specific risk TR = systematic risk + unsystematic risk TR = undiversifiable risk + diversifiable risk Decisions required for successful trading system - 1. Markets 2. Position sizing 3. Entries 4. Stops 5. Exits 6 Tactics 5 Initial decisions for setting up a system - 1. Model to use. 2. Markets to trade in. 3. Time horizon 4. Risk control plan 5. Evaluation plan Primary problem of optimization - Curve fitting to the data. profit factor and levels - total profit/total loss must be greater than 1. greater than 2 is good. over 10 is a warning of curve fitting payoff ratio and levels - avg. winning trade/avg. losing trade. greater than 2 is good % of winning trades levels - >60% for profit systems 30%-50% for trend fol lowing systems MAR ratio and levels - Profit/MDD should be greater than 1 3 Ways to create synthetic data - 1. Monte Carlo 2. Random numbers 3. Wolberg's Expert trading systems Information ratio and level for a robust system - Returns/st. deviation should be within 2:1 range. Assumptions for theory of utility - 1. Investors are risk averse. 2. Decisions are made by risk/expected return only 3. Risk is determined by variance or st. deviation of expected returns. Assumptions of Linear regression - 1. normality of returns 2. linear relationship between independent and dependent variables. Non parametric regression - regression that relaxes linearity assumption and makes no assumption of normality Commodity that best correlated with the DXY - Gold Equity index that best correlated with DXY - Canada's Venture Index which is heavily weighted in gold mining stocks Index with Highest correlation to XOI (Oil Index) - Canada's TSX index Did Japanese bonds or US Treasuries better correlate with the XO I? - Japanese bonds had better correlation. What VIX values are associated with higher volatility? Lower volatility? - VIX>30 = higher volatility VIX<20 = lower volatility/complacency Reason for rising correlations between S&P500 and International indi ces. - Impact of globalization and free money flow across national borders. What happens to correlation of bond yields and stock prices in recession? - Bond yields and stock prices become positively correlated. Bond prices rally, pushing yields lower a nd stock prices move lower. Rising inflation/commodity prices effects on bonds? - Rising inflation is negative for bond prices which increases yields. What index did the DAX best correlate with? - Euro Stoxx 50; then CAC 40 Why is gold a long -term medi ocre investment? - -stocks do better vs. inflation in the long-term since companies can raise prices when inflation rises. -gold stays in the market What leads? Gold stocks or Gold bullion? - Gold stocks lead gold bullion 2 reasons countering momentum myth that momentum can only be exploited on the short side - -Kenneth French study of trading long upward moving stock and short downward moving stocks showed equal contribution -Israel and Moskowitz study show long and short are equally profitable. 2 reasons why momentum is advantageous for taxable investor - 1. momentum holds winners longer and sells losers 2. momentum usually does not invest heavily in high dividend stocks which are tax inefficient. 2 theories behind momentum persistance - 1. risk based - momentum premium is compensation for risk 2. behavioral - info. disseminates slowly enough to drive underreactions or overreactions. What does covariance measure? - Measures how two stocks co -vary around their respective means. What does variance measure? - Measures how one stock varies around its own mean What is the correlation coefficient? - It is the scaled covariance which is covariance divided by the product of each variables standard deviation. In terms of diversification, what does the covariance represent? - Covariance represents macro forces of the market. 2 key drivers of beta - 1. stocks correlation with the market. 2. stocks volatility relative to the market. 2 behavioral reasons for breakouts and throwbacks - 1. prospect bias - tendency to be reluctant to gamble with profits. 2 certainty bias - people are happy to lock in a small profit rather than gamble on a bigger profit. What bias explains why resistance turns into support? - Regret bias - investors regre t missing out on buying at the breakout or selling at the breakout and buy when prices move back to the breakout level. What biases causes trends to persist? - 1. Hindsight bias - traders believe they would have bought the dips sold the peaks causing mor e fuel for buying. 2. Ego - traders who bought at peaks, buy more on throwbacks to support in order to prove they made the right decision. 3. Sunk Cost/Loss aversion - traders buy more when prices go down to avoid being wrong and make irrational decisions to remedy the situation. As a trend slows down, what bias kicks in and what do traders do with positions? - Loss -aversion bias kicks in and stops are tightened. Market top to market bottom psychology - 1. during intermediate stage of trend, confirmator y bias and representative bias fuel the trend. Hindsight bias kicks in and traders believe trend won't end. 2. After climax and price starts to move down, cognitive dissonance kicks in and is usually ignored or downplayed. 3. Panic sets in and then traders sell at any price which culminates in selling climax. Investors fail to act as the market starts to rebound. If VIX = 10.4% and S&P 500 is 2472, what is the expected monthly change? - 2472(0.104/sqrt12) = 74.22 points What is fractal efficiency and what does it tell you? - Fractal efficiency measures amount of noise in a market. Near 1 and movement is smooth and no chaos. Enter trades quickly after signal Near 0 and there is a lot of noise and chaos. You can delay entry signals Genetic Algorithms - Sophisticated search method which seeds parameters randomly to find the best set of trading rules. Rules are treated like chromosomes and successful ones are able to mutate and merge to find an optimal solution. Neural networks - Tool used to discover non linear relationships between any combination of fundamental information, technical indicators and price data. Takes inputs and weights them randomly, compares output to history of data to determine if it's correct. Continues to adjust weights until output is correct. Goal of Multiple regression divergence - To predict value of dependent variable from a set of independent variables. Multi step process - examine correlations between independent and dependent variables. -pick most highly correlated independe nt variable first. -add other independent variables to see if they help increase r -squared -if independent variable does not improve r -squared then it is not added -once all markets are added then weights for each are calculated and combined into an index. What should be cap for the Maximum drawdown as % of initial capital of a system? - 3%