CPT Trading Strategies & Market Timing 2 — Questions and Answers
Question 1: A swing trader holds a long position for 4 days and the stock forms a 'bearish engulfing' candlestick pattern on day 4. What is the most appropriate action?
- Add to the position since momentum is building
- Close or reduce the long position as a reversal signal appears (Correct answer)
- Ignore the pattern and wait for the earnings report
- Increase stop-loss distance to allow more room
Correct answer: Close or reduce the long position as a reversal signal appears
A bearish engulfing pattern signals a potential trend reversal, making it prudent to close or reduce a long position.
Question 2: Which market condition best describes a 'range-bound' or 'sideways' market?
- Price consistently makes higher highs and higher lows
- Price oscillates between defined support and resistance levels without a clear trend (Correct answer)
- Price breaks out of a consolidation pattern with high volume
- Price gaps up repeatedly on consecutive trading days
Correct answer: Price oscillates between defined support and resistance levels without a clear trend
A range-bound market is characterized by price oscillating between consistent support and resistance levels with no clear directional trend.
Question 3: The 'opening range breakout' (ORB) strategy uses the high and low established during which time period as its reference?
- The previous day's regular trading hours
- The first 15 to 30 minutes of the current trading session (Correct answer)
- The overnight futures session
- The last hour of the previous trading session
Correct answer: The first 15 to 30 minutes of the current trading session
The ORB strategy uses the price range established in the first 15–30 minutes of the session as breakout levels for trade entries.
Question 4: In mean reversion trading, a stock's price is considered 'statistically stretched' when it trades more than two standard deviations from its moving average. This concept is formalized in which indicator?
- MACD histogram
- Bollinger Bands (Correct answer)
- Ichimoku Cloud
- On-Balance Volume (OBV)
Correct answer: Bollinger Bands
Bollinger Bands plot bands two standard deviations above and below a moving average, visually identifying statistically stretched price levels.
Question 5: A trader uses a 'pairs trade' by going long Stock A and short Stock B from the same sector. The primary risk being hedged is:
- Idiosyncratic company-specific risk
- Broad market directional risk (Correct answer)
- Currency exchange rate risk
- Interest rate duration risk
Correct answer: Broad market directional risk
Pairs trading hedges broad market (beta) risk by holding offsetting long and short positions in correlated securities, leaving exposure only to the relative performance spread.
Question 6: Which of the following best describes the 'three-day rule' used by many technical traders after a significant gap down?
- Buy immediately on the gap-down open to capture the bounce
- Wait three days before entering a long position to confirm the gap does not continue lower (Correct answer)
- Short the stock for exactly three days then cover
- Place a limit order three points below the gap-down open
Correct answer: Wait three days before entering a long position to confirm the gap does not continue lower
The three-day rule suggests waiting three sessions after a large gap down before buying, allowing initial panic selling to exhaust itself.
Question 7: An options trader sells a cash-secured put on a stock they want to own at a lower price. If the put expires worthless, the trader's effective outcome is:
- They are forced to buy shares at the strike price plus premium received
- They keep the premium as profit without acquiring the shares (Correct answer)
- They must buy shares at the current market price
- They lose the entire premium paid
Correct answer: They keep the premium as profit without acquiring the shares
When a short put expires worthless, the seller keeps the entire premium collected as profit without any stock assignment.
CPT Trading Strategies & Market Timing 2
A swing trader holds a long position for 4 days and the stock forms a 'bearish engulfing' candlestick pattern on day 4.
What is the most appropriate action?