Day Trading Advanced Topics 3 — Questions and Answers
Question 1: What is the 'opening range breakout' (ORB) strategy based on?
- Trading the reversal of the first 5-minute candle
- Using the high and low established in the first period as breakout levels for the rest of the day (Correct answer)
- Fading moves that happen at the market open
- Buying stocks that gap down at the open
Correct answer: Using the high and low established in the first period as breakout levels for the rest of the day
The ORB strategy defines a price range established in the first 5, 15, or 30 minutes and then trades breakouts above or below that range with the expectation of continuation.
Question 2: In the context of order flow analysis, what does a 'footprint chart' reveal that standard candlestick charts do not?
- The closing price relative to previous days
- The volume transacted at each individual price level within a candle, split by buy and sell aggression (Correct answer)
- The implied volatility of options at each price
- The number of open short positions at each price
Correct answer: The volume transacted at each individual price level within a candle, split by buy and sell aggression
Footprint charts display the actual volume of buy-initiated vs. sell-initiated trades at each price level inside a candle, revealing where buyers and sellers were most aggressive.
Question 3: What characterizes a 'liquidity vacuum' in day trading, and why is it dangerous?
- A period where trading volume is extremely high, causing slippage
- A price zone with very few resting orders, allowing price to move rapidly through it (Correct answer)
- A broker's margin call that drains account equity
- A technical pattern predicting a trend reversal
Correct answer: A price zone with very few resting orders, allowing price to move rapidly through it
A liquidity vacuum is an area in the order book with few limit orders, so when price enters this zone it can move very quickly, creating significant slippage for traders with stop orders.
Question 4: Which concept describes how the bid-ask spread widens around major economic news releases, and what risk does it create?
- Spread compression; it benefits scalpers entering quickly
- Spread expansion; it increases transaction costs and execution risk during volatile periods (Correct answer)
- Spread normalization; it signals fair value has been reached
- Spread inversion; it triggers circuit breakers
Correct answer: Spread expansion; it increases transaction costs and execution risk during volatile periods
Around major economic releases, market makers widen spreads to protect themselves from directional risk, which can dramatically increase entry and exit costs for day traders.
Question 5: What is 'spoofing' in electronic markets, and why is it illegal under the Dodd-Frank Act?
- Copying another trader's strategy without permission
- Placing and quickly canceling large orders to create a false impression of supply or demand (Correct answer)
- Trading the same stock in multiple accounts simultaneously
- Using a VPN to mask trading activity from regulators
Correct answer: Placing and quickly canceling large orders to create a false impression of supply or demand
Spoofing involves placing large fake orders with no intention of filling them to manipulate other traders' perceptions of supply and demand, which distorts price discovery and is explicitly prohibited.
Question 6: In algorithmic day trading, what is 'latency arbitrage' and why is it controversial?
- Profiting from pricing differences across slow retail brokers
- Exploiting tiny time advantages to trade ahead of slower participants by co-locating servers near exchanges (Correct answer)
- Using delayed news feeds to trade ahead of announcements
- Running trades on multiple exchanges simultaneously to capture price gaps
Correct answer: Exploiting tiny time advantages to trade ahead of slower participants by co-locating servers near exchanges
Latency arbitrage involves high-frequency traders using faster connections and co-location to react to market data milliseconds before slower participants, which critics argue disadvantages retail traders.
Question 7: What does 'tape reading' refer to in modern day trading, and which tool best facilitates it?
- Reading financial news headlines for trade ideas using a news terminal
- Analyzing the real-time stream of time and sales data to gauge buying and selling pressure (Correct answer)
- Reviewing end-of-day charts on paper to plan next-day trades
- Reading brokerage research reports for momentum signals
Correct answer: Analyzing the real-time stream of time and sales data to gauge buying and selling pressure
Modern tape reading involves analyzing the time and sales (T&S) window to interpret the pace, size, and direction of transactions to infer whether buyers or sellers are in control.
Day Trading Advanced Topics 3
What is the 'opening range breakout' (ORB) strategy based on?