Advanced Topics Flashcards

What is 'mean reversion' trading in the context of intraday equities, and what assumption underpins it?

Answer: Fading extreme price moves with the assumption that prices revert toward their average

Mean reversion trading assumes that after an extreme intraday move away from an average or equilibrium, the price will eventually return to that level, so traders fade the extreme move.

How does 'correlation trading' between related securities benefit day traders?

Answer: It uses the movement of a correlated asset as a leading indicator or confirmation for trading another

Correlation trading exploits the tendency for related assets (e.g., sector peers or futures vs. ETFs) to move together, allowing one instrument's move to signal entry or confirmation in another.

What is the purpose of the 'Commitment of Traders' (COT) report for a day trader focusing on futures?

Answer: It reveals the net positioning of commercial hedgers, large speculators, and small traders on a weekly basis

The COT report, published by the CFTC weekly, shows how different categories of futures market participants are positioned, which can reveal when speculative positioning is extreme.

In the context of index futures day trading, what is 'basis' and why does it matter?

Answer: The difference between the futures price and the spot index value, reflecting cost-of-carry

Basis is the difference between a futures contract's price and the underlying spot index value; when basis deviates significantly from fair value, it can signal arbitrage opportunities and predict ETF movements.

What is 'realized volatility' and how does it differ from implied volatility in day trading options?

Answer: Realized volatility is the actual historical price movement; implied volatility is the market's forward expectation embedded in option prices

Realized (historical) volatility measures how much an asset actually moved over a past period, while implied volatility reflects what the options market expects future volatility to be.

Which technique do experienced day traders use to identify institutional accumulation before a breakout?

Answer: Watching for high-volume days at support with small price ranges, indicating buyers absorbing supply

Institutional accumulation often shows up as high volume at a support level with compressed price action, indicating large buyers are absorbing selling pressure without letting the price fall.

What is 'market microstructure' and why is understanding it an edge for advanced day traders?

Answer: The mechanics of how orders interact in the matching engine to create price discovery, spreads, and liquidity

Market microstructure studies how the mechanics of order types, matching engines, market makers, and bid-ask dynamics influence price formation, giving traders insight into execution quality and short-term price behavior.