Stock Trading Case Studies & Practical Application 2 — Questions and Answers
Question 1: An investor bought 100 shares of XYZ at $50. The stock drops to $40 and they buy 100 more shares. What is their new average cost basis per share?
- $40.00
- $45.00 (Correct answer)
- $50.00
- $47.50
Correct answer: $45.00
Averaging down: (100×$50 + 100×$40) / 200 shares = $9,000 / 200 = $45 per share.
Question 2: A trader uses a 2% risk rule and has a $50,000 account. They enter a trade at $100 with a stop-loss at $95. How many shares can they buy?
- 500 shares
- 200 shares (Correct answer)
- 100 shares
- 250 shares
Correct answer: 200 shares
Max risk = $50,000 × 2% = $1,000; risk per share = $100 - $95 = $5; shares = $1,000 / $5 = 200.
Question 3: In 2008, Lehman Brothers' bankruptcy triggered a market-wide sell-off. Which trading strategy would have best protected a long-only equity portfolio?
- Adding more long positions on dips
- Buying put options as portfolio insurance (Correct answer)
- Switching to penny stocks
- Using leverage to amplify gains
Correct answer: Buying put options as portfolio insurance
Protective puts provide downside insurance, capping losses while maintaining upside exposure during market crashes.
Question 4: A stock gaps up 8% at the open on an earnings beat but then reverses and closes flat. This pattern is called:
- A breakout continuation
- A gap and crap (fade) (Correct answer)
- A cup and handle
- A dead cat bounce
Correct answer: A gap and crap (fade)
A 'gap and crap' or fade occurs when a strong open reverses during the session, closing near the prior day's price.
Question 5: Jesse Livermore famously profited during the 1929 crash by short selling. What key risk does short selling carry that long positions do not?
- Dividends are forfeited
- Losses are theoretically unlimited (Correct answer)
- Taxes are higher on short positions
- Margin is never required
Correct answer: Losses are theoretically unlimited
A stock can only fall to zero (capping long losses) but can rise indefinitely, making short-selling losses theoretically unlimited.
Question 6: A trader notices a stock forming a 'death cross' — the 50-day MA crossing below the 200-day MA. What is the conventional interpretation?
- A strong buy signal
- A bearish trend-change signal (Correct answer)
- A neutral consolidation signal
- A dividend announcement indicator
Correct answer: A bearish trend-change signal
A death cross is widely regarded as a bearish signal suggesting the short-term trend has weakened relative to the long-term trend.
Question 7: During the GameStop (GME) short squeeze of 2021, retail traders coordinating on Reddit forced short sellers to buy back shares. This mechanism is called:
- A margin call cascade
- A short squeeze (Correct answer)
- A pump and dump
- A dark pool transaction
Correct answer: A short squeeze
A short squeeze occurs when rising prices force short sellers to cover their positions, creating additional upward buying pressure.
Stock Trading Case Studies & Practical Application 2
An investor bought 100 shares of XYZ at $50.
The stock drops to $40 and they buy 100 more shares.
What is their new average cost basis per share?