CPT Algorithmic & Automated Trading 2 — Questions and Answers
Question 1: What is 'slippage' in the context of algorithmic trading?
- The difference between expected and actual execution price (Correct answer)
- A bug causing the algorithm to skip trades
- The latency between signal generation and order submission
- A penalty fee charged by brokers for rapid order cancellations
Correct answer: The difference between expected and actual execution price
Slippage is the difference between the price at which a trade was intended to execute and the price at which it actually executed, often due to market movement or liquidity constraints.
Question 2: In algorithmic trading, a 'fill-or-kill' (FOK) order requires that:
- The order executes partially within a time limit
- The entire order executes immediately or is cancelled (Correct answer)
- The order remains open until the close of the trading session
- The broker attempts to fill the order at the best available price over 30 seconds
Correct answer: The entire order executes immediately or is cancelled
A fill-or-kill order must be executed in its entirety immediately; if the full quantity cannot be filled at once, the order is cancelled.
Question 3: Which metric best measures an algorithm's ability to avoid adverse market impact when executing large orders?
- Sharpe ratio
- Implementation shortfall (Correct answer)
- Maximum drawdown
- Profit factor
Correct answer: Implementation shortfall
Implementation shortfall measures the difference between the decision price and the final execution price, capturing the full cost of trading including market impact.
Question 4: What does a 'co-location' service provide to high-frequency trading firms?
- Shared compliance monitoring infrastructure
- Physical placement of servers in or near the exchange's data center (Correct answer)
- A cloud-based backtesting environment
- Regulatory-approved algorithm certification
Correct answer: Physical placement of servers in or near the exchange's data center
Co-location allows trading firms to place their servers physically close to the exchange's matching engine, reducing network latency to microseconds.
Question 5: A momentum algorithm that buys assets showing strong recent performance relies on which market anomaly?
- Mean reversion
- Price continuation (Correct answer)
- Calendar effect
- Volatility clustering
Correct answer: Price continuation
Momentum strategies exploit the price continuation anomaly, where assets that have recently outperformed tend to continue outperforming over short to medium horizons.
Question 6: What is the primary purpose of a 'kill switch' in an automated trading system?
- To lock in profits when a target return is reached
- To immediately halt all trading activity in case of system malfunction (Correct answer)
- To prevent trades during high-volatility news events
- To cancel pending orders at the end of each trading day
Correct answer: To immediately halt all trading activity in case of system malfunction
A kill switch is a risk control mechanism that immediately stops all trading and cancels open orders when triggered, protecting against runaway algorithms.
Question 7: In backtesting, 'look-ahead bias' occurs when:
- The strategy is tested on too short a historical period
- Future data is inadvertently used to make past trading decisions (Correct answer)
- The algorithm looks ahead to the next candlestick before placing an order
- Backtests are run forward in time instead of backward
Correct answer: Future data is inadvertently used to make past trading decisions
Look-ahead bias contaminates backtests by allowing the strategy to use information that would not have been available at the time of the historical trade.
CPT Algorithmic & Automated Trading 2
What is 'slippage' in the context of algorithmic trading?