October 2015 CMT LEVEL III

SAMPLE EXAM B
Table of Contents
Section

Number of
Questions

1
2
3
4
5
6
7
8

6
3-10
3-10
3-10
3-10
3-10
3-10
3-10

Topics Covered

Ethics

Each of the exam questions will consist of an

integrated mix of two or three knowledge domains
from among those specified on the mta.org website:
Risk Management, Asset Relationships, Portfolio
Management, Classical Methods, Behavioral
Finance, Volatility Analysis.

Points in
Section
12
20-40
20-40
20-40
20-40
20-40
20-40
20-40

Instructions to Candidates:

This is a sample exam. Questions here are NOT necessarily indicative of the style
you will encounter when taking the Level III examination, but they do include
relevant examples of the topics that will be tested on.
Not all topics in the reading list will appear on a given test. This sample exam
attempts to demonstrate some possible approaches to the various knowledge
domains. Any resemblance to actual test questions is neither implied nor intended.
The scoring on the sample is shown as variable to demonstrate that actual exam
sections may vary in their point count. Individual point counts are placed within
questions to provide an indication of how various questions may be valued. In
general the rule of guidance is that one point will equal one minute of time spent.
Though this will varies from one question to the next, it is a general guideline to
follow for study and time management purposes during the exam.
This is first draft of this sample exam (B form). If errors are evident please send your
observation to Gordon Scott (gordon@mta.org).

Sample Exam Questions

Question #1: Ethics (12 Points)
1A. Jorge Salvador, CMT is a technical analyst for a buy-side firm. He works researching
developing countries with rapidly modernizing economies. Securities laws in these countries
are not as extensive as elsewhere. When Salvador is approached by a corporate owner
within one of these countries, which of the following is correct? (2 points)
A. Salvador does not to worry about violating rules and laws governing insider
information.
B. Salvador must write a report of all his communications and inform management
periodically.
C. Salvador may be required to abide by the requirements of the Code and Standards
even if there is a distinction between rules of the code and developing country.
D. Salvador does not need to be concerned about U.S. rules since he is researching a
developing country.
1B. Bobby Guyer, CMT manages several discretionary accounts for clients as a Registered
Investment Advisor. Bobby has begun to use twitter messages to communicate new ideas he
is looking at as possible short-term trades in his client portfolios. His clients love getting the
information because they feel he is keeping them up to the minute. The problem is that
about half of his client accounts are not suitable for such trades. Bobby has not
communicated with these clients about the difference in the trades he sends out on twitter.
Some of the clients he has have begun to ask for more information about how they can
participate in such trades, which is Bobbys intent. Which of the following is most accurate
regarding Bobbys de facto marketing behavior? (2 points)
A. Bobby is not in violation Standard III(C) because his communications comply with
the existing guidance and regulation governing use of social media.
B. Bobby is not in violation Standard III(C) because he does not force any trades on his
clients.
C. Bobby is in violation of Standard III(C.2) because his recommendations are not
consistent with the original mandate given him for half of his clients.
D. Bobby is in violation of Standard III(C) because he manages discretionary accounts.

1C. Scott Fielding, CMT is a strategist for a firm that manages high-net-worth portfolios at a
large global bank. The Director of sales has asked him for some figures to help launch a new
specialized fund offering based on one of his strategies. The Director is looking for a 5 year
track record. Scott only has one year of out-of sample data trading the system, the other four
years are a back test. The director persuades him that the firm should publish all five years
of data. Which of the following statements is most likely correct? (2 points)
A. Fielding and the Director have solid data on the strategy so they are not
misrepresenting the performance over the past five years.
B. Fielding and the Director have violated Standard II (A) by sharing material nonpublic
information.
C. Fielding and the Director have violated Standard I(C) by misrepresenting their data as
actual performance data instead of theoretical modeling and backtesting.
D. Fielding and the Director have violated Standard III by not dealing fairly with the
clients.

1D. Shelly Ulsterlow, CMT is a senior technical analyst for an investment banking firm. She is
frequently asked to make media appearances on market conditions. In the course of a recent
appearance, her interviewer asked her about a sizable position her bank was rumored to have
purchased in a pre-IPO company. Although Ulsterlow didnt know anything about this
situation, she did not want to appear uninformed about her own company so she
acknowledged the rumor and began to articulate information she assumed would be correct.
Which of the following statements is most accurate? (2 points)
A. Ulsterlow is protected by the First Ammendment of the U.S. constitution and can say
whatever she wants as part of journalistic license.
B. Ulsterlow is not in violation of any of the CFA Standards of Professional Conduct.
C. Ulsterlow is in violation of multiple standards listed in the CFA Standards of
Professional Conduct.
D. Ulsterlow is in violation of only Standard II(B) because her statements may
manipulate the perceived market value of the pre-IPO company.

1E. Ren Griswold, CMT manages a portfolio of managed futures accounts for several
institutional clients. He invests in various spread strategies involving a number of
commodities. Griswold has a hunch that Gold prices are about to soar higher. In the past his
hunches have been highly profitable investments, so he asks his technical analyst to draft up
a bullish outlook for gold that he can use to help persuade his clients to allocate more money
towards gold than his mandate normally allows. Which of the following statements about
Griswold is the most accurate? (2 points)
A. Griswold should do the analysis himself so that is not likely to be in violation of
Standard III(A) by not acting with prudence and care.
B. Griswold should do the analysis himself because the data is likely to be
misrepresented otherwise.
C. Griswolds associate is not likely to be objective with his report and sharing that
information would be in violation of Standard I(B).
D. Griswolds associate is not likely to be objective with his report and sharing that
information would be in violation of Standard II(D).

1F. James Bunson, CMT is a proprietary trader who has been trading a system he has developed
and refined over the past five years. His firm intends to soon use the system in an automated
fashion as part of their CTA business. Bunson finds one day that his performance data has
inadvertently been overstated for the past year by about a third. Because the firm is only two
weeks away from launching their offering, Bunson decides to say nothing. Which of the
following statements is most likely to be accurate? (2 points)
A. Bunson is not yet in violation of any standards.
B. Bunsons system still makes money even if the performance is slightly overstated, so
it really doesnt matter that he may be off the mark just a little.
C. Bunson is in violation of Standard III(D) by not ensuring that the data is accurate.
D. Bunson is in violation of Standard IV(A) by being disloyal to his employer.

Question #2: Behavioral Finance (20 to 40 Points)

2A. Identify which five of the following are phases of an asset bubble as Montier describes
them, and give a description of each: (5 points, 1 point each.)
A. Lethargy markets going nowhere
B. Displacement exogenous shock triggers profit opportunity in some sectors but not in
others
C. Credit creation boom and monetary expansion
D. Debt Consolidation consumer confidence dissipates
E. Euphoria overestimate of returns
F. Critical stage financial distress as insiders cash out and firms consider defaulting
G. Revulsion investors stop participating, paralyzed by fear
H. Capitalization traders take advantage of market moves
I. Recovery markets begin to rebound
J. Transition capital markets become more liquid

Question #3: Asset Relationships (20-40 Points)

You are a large-cap portfolio manager. Despite your large-cap mandate, you like to monitor the
relative strength ratio of the small cap stock index divided by the large cap stock. After a
nine-month downtrend this relative strength ratio has put in a bottom and has started to
move higher.
3A. What sector should you consider adding exposure to? (3 points)
A.
B.
C.
D.

Staples
Tech (3 points)
Telecom
Utilities

3B. Give two reasons why small-cap relative strength suggests you should add to this sector?
(6 points)

3C. Copper has been selling off for the past month on an absolute basis and relative to other
currencies. As an Emerging Market equity manager, which country should you consider
reducing exposure in? (3 points)
A.
B.
C.
D.

China
India
Mexico
Russia

3D. Explain one reason why weakness in copper would cause you to consider reducing exposure
to this country? (5 points)

Question #4: Risk Management (30 Points)

4A. Risk control can involve complex mathematics, but there are a number of common sense
principles the investment professional can follow to reduce the risk of ruin. List 3 of the
most important, common sense risk-control rules according to Kaufman. (9 points)

4B. You work for a CTA firm and have worked hard to develop several viable trading systems
covering a diversified variety of market instruments. You have taken care to properly test
these systems, avoiding data snooping, or curve-fitting them to in-sample data. Next, you
merged these several systems into an overall portfolio model. What method you might you
use to test your hypothesis and determine the probability of your trading system succeeding?
Briefly describe that testing method and its meaning.
4C. Your latest system is a trend-following system and the market conditions were favorable for
trend-following during the last year. The general partner of your CTA firm wants to put
your system in place this year, but before doing so he wants you to explain what could go
wrong.
Which of the following would you say is the main disadvantage of a trend following
system?
A.
B.
C.
D.

Pyramiding position size, as the trend continues, increases risk.

Position size has to be maintained in both trending and trendless market environments.
As the trend advances, risk increases and the advantage of the fat tail declines.
In a trendless market a series of small losses can occur which can add up to a large
drawdown.

4D. List three steps that, when added to a trading plan, would limit the major disadvantage of a
simple trend-following system. (6 points total, 2 per answer below)

4E. The general partner of your hedge fund tells you that he would like to use the Calmar Ratio
as a measure of performance for your system. Explain what this ratio is and give one reason
why the general partners choice is, or is not, likely to be a useful measure of your systems
performance as a part of delivering value to the firms clients.

Question #5: Classical Methods (20-40 Points)

Chart 5-1
5A. You are newly hired on to XRHO Capital Management a CTA firm. Last year the firm took
a long position in Coffee Futures (KC). The position is profitable and has met its objectives,
and you are tasked with recommending whether the current conditions suggest it would be
most favorable to sell now or to wait. Select either decision but explain at least four points
of evidence to correctly support your decision from among the applicable signals on chart 5 1. (12 points)

5B. Your predecessor recommended the firm initiate a short position on MMM, but failed to
leave any explanation for this chart. Describe the three signals the analyst likely observed
using available detail on chart 5-2. (10 points)

5C. Your predecessor recommended the firm enter the short position at $125 and set a stop loss
at $130. If the firm had a fund of 5 million dollars and wanted to take the trade and put only
1.5% of that amount at risk, how many shares could be traded (assuming no loss to gaps or
slippage)? (3 points)

QUESTION #6: Classical Methods (20-40 Points)

Chart 6-1
Examine Chart 7-3 (10 Year US Treasury Prices).
6A. Identify which circle contains the candle (1, 2, 3, or 4) that was most significant in
forecasting a break above the resistance line? (3 points)
6B. Explain two reasons for your selection in 6A. (6 points)

6C. What is your short-term forecast for US Treasury Bond Prices based on this chart?
(10 points)

QUESTION #7: Classical Methods (20-40 Points)

Chart 7-1
7A. You are a recently hired analyst. Your portfolio manager wants your short-term
recommendation on GDX, a gold-mining ETF. You must make the best recommend
whether it be a LONG or SHORT position, and you must provide evidence to support your
conclusion. Examine Chart 7-1: GDX. Do you recommend a LONG or SHORT position in
this security? Name and discuss the implication of the 2 most recent multi-day candlestick
patterns that support your conclusion. For each candle, comment if there is anything
significant in the chart that increases the strength of each candle pattern? (7 points)
7B. In Chart 7-1 how do the indicators Williams %R and ATR factor into your analysis? (5 pts)

7C. Determine how many shares can be traded (long or short), rounded to the nearest 100
shares. Use Chart 7-1 and assume the following conditions and demonstrate how you
arrived at your answer: (4 points)

Trade entry price of $24.50 (long or short).

Position risk limited to $15,000.
Use ATR to calculate your stop price. Assume the last ATR reading is .86. Use a
factor of 1.5 in your ATR stop calculation.

Chart 7-2
7D. Examine the 4 labeled circles in Chart 7-2. In each circle there is a multi-day candlestick
pattern. Which circle contains a candlestick pattern that did not perform in-line with its
standard forecast? (2 points)
A.
B.
C.
D.

Circle 1
Circle 2
Circle 3
Circle 4

7E. What name would you give to the pattern you selected in question 7D? (2 points)

7F. Having examined the fundamentals of the security in Chart 7-2, a research firm just released
an official sell recommendation on it today. Comment on whether or not the provided
indicators, MACD and Money Flow, are overbought at their current levels. In your
opinion, do these indicators support the firms conclusion to sell the stock today? In your
answer, provide a brief definition of how each indicator works. (11 points)

Question #8: Risk Management (20-40 Points)

All technical analysis based trading systems have a random component as well as a
predictive component. In order to make a trading system as robust as possible, we must
reduce the random component where possible during the back test development phase, or
what Aronson calls the data mining bias. He defines the data mining bias as the expected
difference between the returns observed during the data mining phase (back testing) and its
true expected performance trading live in the future. Aronson defines five factors that
determine the magnitude of the data mining bias. Answer the following questions regarding
each of them.

8A. The number of rules back tested. As the number of rules increases, does the data mining
bias increase or decrease? Explain one reason why. (5 points)

8B. The number of observations (the number of trades in the back test) used to compute
the performance statistics. Does more observations (trades) increase the bias or decrease
the bias? Explain one reason why. (5 points)

8C. Correlation among rule returns. Will five uncorrelated rules increase or decrease the bias
when compared to five highly correlated rules? Explain one reason why. (5 points)

8D. Percentage of positive outlier returns. Will return samples with fat tails comprised of
several extreme values increase or decrease the data mining bias? Explain one reason why.
(5 points)

8E. Variation in expected returns among the various rules. If the variation in return among
the expected rules is low, is the data mining bias lower or higher? Explain one reason why.
(5 points)

8F. Which of the five factors (above) is the most important in reducing the data mining bias
(randomness)? (5 points)

Question #9: Asset Relationships (20-40 Points)

Chart 9-1
Chart 9-1 shows a comparison between GLD and XAU. Here GLD is being used as a proxy for
Gold prices. This chart attempts to visually identify two-week periods where the relationship
between these two entities forecasts the behavior of GLD prices over the subsequent four weeks.
9A. Katsanos noted a short-term relationship between the XAU index and gold prices in which
he stated that XAU was a ____________ (leading/lagging) indicator compared to gold. (3 points)

9B. Which of the two sets of indicator areas (marked by grey-shading or blue-shading columns)
confirms the choice you made in 9A? (4 points)

9C. Describe whether these areas confirm your understanding of Katsanos observations about
whether XAU leads gold or gold leads XAU. (5 points)

9D. Describe the qualifications and limitations a responsible technical analyst should consider
when making a visual observation such as the one above. (10 points)

Answers
Question 1 Key
All answers are C
Question 2 Key
Reference:
Chapter 29)

Montier, Behavioural Investing, Chapter 36 The Anatomy of a Bubble (eBook

(1 point each for id) Displacement, Credit creation, Euphoria, Critical stage (financial
distress), Revulsion
(4 points each for description)
Displacement: exogenous shock triggers creation of profit opportunity in some sectors while
shutting down others. Opportunity created is greater than those shut down. Investment picks up
to exploit new opportunity.
Credit creation: Boom exacerbated by monetary expansion/credit creation. Easy money leads to
price increases.
Euphoria: Speculation for price (momentum) is added to investment for production. Adam
Smith referred to is as overtrading. Overestimate of future returns or excessive gearing.
Critical stage (financial distress): Insiders take profits and cash out. Significant insider selling.
Financial distress is when a firm contemplates not meeting its liability obligations. As distress
persists, perception of the crisis increases. Bank failures.
Revulsion: Paralyzed with fear, investors can no longer participate. Capitulation is generally
used when a bull finally admits defeat.

Question 3 Key

References:
Katsanos, Markos: Intermarket Trading Strategies, Chapter 3 (Chapter 14 in eBook)
Weigand, Robert A.: Applied Equity Analysis and Portfolio Management, Chapter 2 (Chapter 21
in eBook)
3A. What sector should you consider adding exposure to? (3 points)
A.
B.
C.
D.

Staples
Tech
Telecom
Utilities

3B. Give two reasons why small-cap relative strength suggests you should add to this sector?
(6 points)
Small-caps tend to lead large-caps coming out of bear markets (3 points)
Tech is typically early cycle leader (3 points)

3C. Copper has been selling off for the past month on an absolute basis and relative to other
currencies. As an Emerging Market equity manager, which country should you consider
reducing exposure in? (3 points)
A.
B.
C.
D.

China
India
Mexico
Russia

3D. Explain one reason why weakness in copper would cause you to consider reducing exposure
to this country? (5 points)
China is the worlds largest producer and consumer of copper

Question 4 Key
References:
Kaufman, Perry: Trading Strategies and Methods, Chapter 23 (Chapter 12 in eBook)
Kaufman, Perry: Trading Strategies and Methods, Chapter 21 (Chapter 10 in eBook)
Aronson, David: Evidence Based Technical Analysis, Chapter 5 (Chapter 23 in eBook)

4A. Risk control can involve complex mathematics, but there are a number of common sense
principles the investment professional can follow to reduce the risk of ruin. List 3 of the
most important, common sense risk-control rules according to Kaufman. (9 points)
Possible answers (3 points each for any answer specified below)
1. Only risk a small amount of total capital on any one trade: no more than 5%.
2.Determine the maximum loss for the current trade in advance.
3. Exit a trade quickly.
4. Don't meet margin calls.
5. Liquidate your worst position first when lightening up.
6. Be consistent in your trading philosophy.
7. Be sure the trading profile is compatible with your risk preference.
8. Plan for contingencies. Be prepared for exceptions.
[Kaufman, page 1032]

4B. You work for a CTA firm and have worked hard to develop several viable trading systems
covering a diversified variety of market instruments. You have taken care to properly test
these systems, avoiding data snooping, or curve-fitting them to in-sample data. Next, you
merged these several systems into an overall portfolio model.
According to your readings, what would be the next testing method you would choose to
determine the probability of your trading system succeeding, given a wide variety of
possible market scenarios going forward?
Briefly describe that testing method and its meaning.
Answer
Monte Carlo permutation (2 points). This method estimates the sampling distributions shape by
randomly resampling the original sample of observations so as to produce new computergenerated samples. This in turn generates the P&L trade data from a system from 100 to 2000
times and generates an equity curve for each simulation. If the great majority of the equity lines
of these 100 to 2000 simulations are without substantial drawdowns (beyond your acceptable
threshold) and meet your profitability requirements, then your portfolio system is probably
robust. It is more likely to be profitable and less likely to fail going forward. (4 points)
Kirkpatrick and Dahlquist (2011)

4C. Your latest system is a trend-following system and the market conditions were favorable for
trend-following during the last year. The general partner of your CTA firm wants to put
your system in place this year, but before doing so he wants you to explain what could go
wrong.
Which of the following would you say is the main disadvantage of a trend following
system?
A.
B.
C.
D.

Pyramiding position size, as the trend continues, increases risk.

Position size has to be maintained in both trending and trendless market environments.
As the trend advances, risk increases and the advantage of the fat tail declines.
In a trendless market a series of small losses can occur which can add up to a large
drawdown.

Answer
D. In a trendless market a series of small losses can occur which can add up to a large drawdown.
(2 points)
4D. List three steps that, when added to a trading plan, would limit the major disadvantage of a
simple trend-following system. (6 points total, 2 per answer below)
Answer
1. We can reduce the size of our trades or stop trading trend-following systems completely if we
use one of a variety of methods designed to identify non-trending markets, such as ADX.
[Kaufman, page 1063.] (2 points)
2. We can cut back on trading or stop trading trend-following systems completely when our
equity curve declines by a predefined amount. Kirkpatrick and Dahlquist (2011), on page 577,
wrote that a standard for closing the entire portfolio model is a percentage stop, usually around
20%.(2 points)
3. We can cut back on trading or stop trading trend-following systems completely when our
equity curve itself enters a quantified and predefined downtrend. (2 points)
[Kaufman, page 1032.]

4E. The general partner of your hedge fund tells you that he would like to use the Calmar Ratio
as a measure of performance for your system. Explain what this ratio is and give one reason
why the general partners choice is, or is not, likely to be a useful measure of your systems
performance as a part of delivering value to the firms clients.
Calmar Ratio = CAGR / Maximum Drawdown over 3 years
The Calmar Ratio is a useful measure of performance as a part of delivering value to the firms
clients.
Calmar Ratio is favored by hedge funds because it reflects gain to pain in the most realistic way,
with consideration given to time, the way (often impatient) investors look at it. (7 points)
Kaufmann, 1037, 1038

Question 5 Key:

Chart 5-1
5A. You are newly hired on to XRHO Capital Management a CTA firm. Last year the firm took
a long position in Coffee Futures (KC). The position is profitable and has met its objectives,
and you are tasked with recommending whether the current conditions suggest it would be
most favorable to sell now or to wait. Select either decision but explain at least four points
of evidence to correctly support your decision from among the applicable signals on chart 5 1. (12 points)
Answer (either sell now or hold):
Sell now.
1) Falling wedge pattern failure. Coffee prices failed to meet the formulated price target of $220
(from the $220 - $160 range where $60 is height of the wedge). The high of the trend from the
subsequent pattern break out was around $208. Bearish. (3pts)
(ebook 1177)
2) The last day of Coffee price action traded below the PSAR indicator which is bearish. (3pts)
(Kaufman page 790, ebook 229)
3) The slow stochastic is still bearish from the last overbought reading above 80 when the %K
line crossed the %D line. (3pts)
(ebook 6)
4) Potential short term Double Top. Coffee prices failed to rally above the recent high at $208.
Bearish. (3pts)
(ebook 1040)

Hold (wait).
Recent coffee price action is converging at four major support levels
1) At the lower Bolllinger Band level. (3pts)
2) At the Fibonacci 38.2% retracement level. (3pts)
3) At the MVWAP level. (3pts)
4) At the $175 price which is short term price consolidation support between the recent two
highs (3pts)
(ebook 175)

5B. Your predecessor recommended the firm initiate a short position on MMM, but failed to
leave any explanation for this chart. Describe the three signals the analyst likely observed
using available detail on chart 5-2. (10 points)
Two signals that are supportive of a short position are,
Rising prices on Declining trade volume divergence. (3pts)
Rising prices and Declining RSI momentum divergence. (3pts)
Others may be possibly noted
(ebook 5, 47, 48, 271 and others)

5C. Your predecessor recommended the firm enter the short position at $125 and set a stop loss
at $130. If the firm had a fund of 5 million dollars and wanted to take the trade and put only
1.5% of that amount at risk, how many shares could be traded (assuming no loss to gaps or
slippage)? (3 points)
1.5% of $5MM is $75,000 therefore in order to contain your risk of loss to that amount, the
position size in 3M (MMM) should be set at 15,000 shares sold short at the $125 price target
level.
(ebook 473 Method of trades with equal initial position risk)

Question 6 Key:
References
Examine Chart 6-1 (10 Year US Treasury Prices).
6A. Identify which circle contains the candle (1, 2, 3, or 4) that was most significant in
forecasting a break above the resistance line? (3 points)
Circle 4
(ebook 932)

6B. Explain two reasons for your selection in 6A. (6 points)

The very small body of the candle closed at the high point, well above the lows earlier in the day. (4
points) A named price pattern here such as long lower shadow, hammer, or even dragonfly doji or any
other bullish pattern would be awarded extra (2 points)

(ebook 932-4)

6C. What is your short-term forecast for US Treasury Bond Prices based on this chart?
(5 points)
Based on the fact the resistance line was broken, and both closed near the high (2 white candles above it)
it is more likely that US bond prices will rise in the short-term. (5 pts).

(ebook 946)

Question Key 7

Chart 7-1
7A. You are a recently hired analyst. Your portfolio manager wants your short-term
recommendation on GDX, a gold-mining ETF. You must make the best recommend
whether it be a LONG or SHORT position, and you must provide evidence to support your
conclusion. Examine Chart 7-1: GDX. Do you recommend a LONG or SHORT position in
this security? Name and discuss the implication of the 2 most recent multi-day candlestick
patterns that support your conclusion. For each candle, comment if there is anything
significant in the chart that increases the strength of each candle pattern? (7 points)

Long (1 pt). If candidate selects short then they lose all 7 points for this question.

Separating Lines is the most recent pattern (1pt).

This is a continuation pattern (1pt).
Given the fact a window occurred before it and price action has now crossed the moving average
line, this increases the strength of this bullish signal (1pt)
Bullish Engulfing is the next most recent pattern occurring around Oct 15 th (1pt).

This is also reversal pattern, occurring near the bottom (1pt).

The bullish engulfing candle engulfs two prior (small body) candles increasing its significance (1
pt)..

NOTE: Some candidates may suggest that a harami is present on Oct 15 th. However, a bullish
nd

harami reversal needs to have a solid black candle followed by a smaller candle (the 2 candle
can be white or black).
Reference: See Nison, 82-84. Also, since this question is asking for a multi-day candle pattern,
the window does not count for credit.

7B. In Chart 7-1 how do the indicators Williams %R and ATR factor into your analysis? (5
points)

Williams is a momentum oscillator, like RSI or Stochastics, but its scale is inverted. It is at an
extreme overbought reading of 10 right now, and may be flattening out. (1 pt).

(ebook 549)

However, this extreme reading does not always mean sell. If this is the start of a new trend,
since price action is now above the moving average, a momentum oscillator can stay overbought
for a period of time as the trend continues. This occurred 2 prior times in the chart (2 pts).

(ebook 549)

ATR helps to measure volatility. Volatility has been declining as the security declined (in the last
downtrend). There are a couple acceptable responses here: 1. typically after a period of low
volatility, volatility tends to increase. Based on this chart, ATR is at its lowest range. Since the
security just broke above its moving average line, it is possible that we will see increased
volatility (but not confirmed yet). 2. ATR can be used as a breakout filter. If the breakout
exceeds the ATR level, it helps to confirm the breakout. In this case, the recent break above the
moving average with the gap is more than 86 cents helping to add validity to the breakout. (2 pts)
(Reference, ebook 259-260)

7C. Determine how many shares can be traded (long or short), rounded to the nearest 100
shares. Use Chart 7-1 and assume the following conditions and demonstrate how you
arrived at your answer: (4 points)

Trade entry price of $24.50 (long or short).

Position risk limited to $15,000.
Use ATR to calculate your stop price. Assume the last ATR reading is .86. Use a
factor of 1.5 in your ATR stop calculation.

Answer: 1.5 times an ATR of 86 cents = $1.29. The stop would be placed $1.29 below the long entry
price, at $23.21. (2 pts for correct discussion of stop price). Thus, rounding to the nearest hundred, a
total of 11,600 shares could be purchased at 24.50. (2 pts for correct number of shares).

(ebook 293-303)
-

Chart 7-2
7D. Examine the 4 labeled circles in Chart 7-2. In each circle there is a multi-day candlestick
pattern. Which circle contains a candlestick pattern that did not perform in-line with its
standard forecast? (2 points)
A.
B.
C.
D.

Circle 1
Circle 2
Circle 3
Circle 4

Answer: D
Rationale: Circle 4 contains an advance block pattern, which consists of 3 successively smaller white
bodied candles during an uptrend. It is not an advancing white soldiers pattern. Typically, the standard
forecast for an advance block is that the trend stalls or reverses which is clearly not the case here.
Reference: Nison, 99

7E. What name would you give to the pattern you selected in question 7D? (2 points)
Answer: advance block or deliberation (either is acceptable)

7F. Having examined the fundamentals of the security in Chart 7-2, a research firm just released
an official sell recommendation on it today. Comment on whether or not the provided
indicators, MACD and Money Flow, are overbought at their current levels. In your
opinion, do these indicators support the firms conclusion to sell the stock today? In your
answer, provide a brief definition of how each indicator works. (11 points)
Answer: MACD cannot be overbought as it is not bound to a 0-100 scale, like a typical oscillator (2
pts). It does not support the sell recommendation. (1 pt). The 12 and 26 day moving averages
continue to trend upward above the zero (signal) line, with the faster average staying above the slower
one. There are no immediate signs of those two averages crossing, showing continued upward strength.
(2 pts)
The Money Flow Index is considered overbought, as it is above 80. (2 pts). This index is confined to a
range between 0 and 100. However, despite its high levels, it does not warrant an immediate sell
recommendation. Oscillators can stay in overbought territory for some time in strong uptrends (2 pts).
This oscillator accounts for the up days vs the down days, multiplied by daily volume. If a days avg
price is higher than the previous days, then there is positive money flow. In this case we see a continued
uptrend in the Money Flow Index (we dont see a move back below the overbought line) signifying that
volume is also following the advances. (2 pts).

(ebook 5)

Question 8 Key

Reference:
Aronson, David R., Evidence-Based Technical Analysis, Chapter 5 and 6.
Aronson defines five factors that determine the magnitude of the data mining bias. Answer
the following questions regarding each of them.
The general idea behind these questions is to address the idea of randomness -- less is good,
and more is bad. Acceptable answers can use any combination of random, randomness,
predictable, predictability, unpredictable, good luck, bad luck, data mining bias, and other
similar words.
8A. The number of rules back tested. As the number of rules increases, does the data mining
bias increase or decrease? Explain one reason why. (5 points)
Increases (2 pts)
(3 pts) As the number of rules increases, the chance that one set of rules will give
extraordinary results increases, increasing the odds of randomness. The smaller the number
of rules, the lower the odds that one set of rules will stand out.
8B. The number of observations (the number of trades in the back test) used to compute
the performance statistics. Does more observations (trades) increase the bias or decrease
the bias? Explain one reason why. (5 points)
Decreases (2 pts)
(3 pts) The greater the number of observations (trades) used to compute the performance
statistics, the smaller the dispersion of the statistic's sampling distribution. The more
observations (trades) that are in the sample, the lower the odds that a lucky few will result in
a high mean return.
8C. Correlation among rule returns. Will five uncorrelated rules increase or decrease the bias
when compared to five highly correlated rules? Explain one reason why. (5 points)
Increase (2 pts) Note: Uncorrelated rules will increase bias, Correlated rules will decrease
bias. Both statements are acceptable.
(3 pts) A higher correlation among the rules has the effect of reducing the number of rules,
whereas a lower correlation has the effect of increasing the rules. The more dissimilar the
rules, the greater the opportunity to have a great coincidental fit to the historical data, and
therefore very high performance due to good luck.

8D. Percentage of positive outlier returns. Will return samples with fat tails comprised of
several extreme values increase or decrease the data mining bias? Explain one reason why.
(5 points)
Increase (2pts)
(3 pts) Within a constant sample size, a greater number of extreme values can create a large
data mining bias. The size of the bias will depend on how extreme the values are and how
many observations (trades) are in the sample. With a small sample size even one or two
extreme positive values can dramatically boost the sample mean.

8E. Variation in expected returns among the various rules. If the variation in return among
the expected rules is low, is the data mining bias lower or higher? Explain one reason why.
(5 points)
Higher (2 pts)
(3pts) If the rules have approximately the same merit, the difference in performance will be
due primarily to luck, However, if one rule begins to stand out statistically, it will be
selected most of the time since its predictive power is greater than the other rules, and
therefore its data mining bias is lower.

8F. Which of the five factors is the most important in reducing the data mining bias
(randomness)? (5 points)
(5 pts) The number of observations (trades) is the single most important factor in reducing
randomness. Acceptable references: law of large numbers, greater amount of testing under
variety of conditions, robustness in backtesting etc.,

Question 9 Key
Reference:
Katsanos, Markos, Intermarket Trading Strategies, Chapter 7
Aronson, David R., Evidence-Based Technical Analysis, Chapter 5 and 6.
Chart 9-1 shows a comparison between GLD and XAU. Here GLD is being used as a proxy for
Gold prices. This chart attempts to visually identify two-week periods where the relationship
between these two entities forecasts the behavior of GLD prices over the subsequent four weeks.
9A. Katsanos noted a short-term relationship between the XAU index and gold prices in which
he stated that XAU was a leading (leading/lagging) indicator compared to gold. (3 points)

9B. Which of the two sets of indicator areas (marked by grey-shading or blue-shading columns)
confirms the choice you made in 9A? (4 points)
Should be grey-shading if 9A was answered correctly, but if the answer above was selected as
lagging then they should select blue-shading for the correct answer here. Since the questions is
about whichconfirms they must be consistent with their choice on 9A to get credit

9C. Describe how these shading areas confirm your understanding of Katsanos observations
about whether XAU leads gold or gold leads XAU. (5 points)
This visual information confirms that XAU leads gold price at some points, but not always,
which is consistent with what Katsanos observed. Since XAU is being compared to GLD and not
gold spot prices, you could expect more inconsistency, so having three examples going both
ways is not unexpected in this graphic.
9D. Describe the qualifications and limitations a responsible technical analyst should consider
when making a visual observation such as the one above. (10 points)
Katsanos said these were short-term correlations only. So while this is an interesting observation
and a nice, anecdotal confirmation, even if it were conclusive, it should only be discussed as a
short-term forecasting tool. However, this chart alone could not be used as a clear demonstration
of Katsanos observations. Further it would be irresponsible to use this chart to conclude a
definitive forecast on Gold prices while citing Katsanos, because this is not the exact same
relationship and without a solid study (consistent with Aronsons writings) on GLD vs. XAU
price behavior, a technician should not use this to form the basis of a recommendation in the
short term.

Errata
1. 10/14: Removed extra items not intended in question 7