Stock Trading Case Studies & Practical Application 5 — Questions and Answers
Question 1: A day trader makes 10 trades per day, each risking $50, with a 55% win rate and 1:1 reward-to-risk. After commissions of $5 per trade, is this strategy net profitable?
- Yes, the edge overcomes commissions
- No, commissions eliminate the edge (Correct answer)
- Yes, but only on winning days
- No, because the win rate must exceed 60%
Correct answer: No, commissions eliminate the edge
Daily edge = 10 trades × [(0.55×$50) - (0.45×$50)] = $10; commissions = 10×$5 = $50, leaving a -$40 net loss per day.
Question 2: The SEC's Regulation SHO requires short sellers to locate shares before shorting. A broker fails to deliver shares on settlement day. This is called:
- A margin call
- A naked short sale or fail-to-deliver (Correct answer)
- A short squeeze
- A covered short
Correct answer: A naked short sale or fail-to-deliver
A fail-to-deliver occurs when the seller cannot provide shares by settlement, which may indicate naked short selling violating Reg SHO.
Question 3: A trader backtests a strategy on the same data used to develop it and gets excellent results. When live-trading, performance is much worse. This is known as:
- Slippage
- Curve fitting or overfitting (Correct answer)
- Beta slippage
- Survivorship bias
Correct answer: Curve fitting or overfitting
Overfitting (curve fitting) occurs when a model is tuned so precisely to historical data that it captures noise rather than true signal, failing out-of-sample.
Question 4: In the 2020 COVID crash, markets fell 34% in 23 days but fully recovered within months. An investor who panic-sold at the bottom and re-entered at the top would have:
- Broken even due to the recovery
- Locked in losses and missed the recovery gains (Correct answer)
- Profited from buying at the bottom
- Outperformed a buy-and-hold investor
Correct answer: Locked in losses and missed the recovery gains
Selling at the bottom realizes losses permanently, and re-entering at the top misses the recovery, resulting in significant underperformance versus holding.
Question 5: A company repurchases 10% of its outstanding shares. All else equal, what happens to earnings per share (EPS)?
- EPS decreases by 10%
- EPS increases because fewer shares divide the same earnings (Correct answer)
- EPS is unaffected by buybacks
- EPS doubles
Correct answer: EPS increases because fewer shares divide the same earnings
With 10% fewer shares outstanding, the same total earnings are divided among fewer shares, mechanically increasing EPS.
Question 6: A portfolio has a Sharpe ratio of 0.3 while a benchmark has a Sharpe ratio of 1.2. What does this indicate?
- The portfolio has higher raw returns
- The portfolio generates poor risk-adjusted returns relative to the benchmark (Correct answer)
- The portfolio has lower volatility
- The portfolio is better diversified
Correct answer: The portfolio generates poor risk-adjusted returns relative to the benchmark
A lower Sharpe ratio means the portfolio earns less excess return per unit of risk, indicating inferior risk-adjusted performance versus the benchmark.
Question 7: A trader holds a losing position and keeps adding to it, convinced it will recover, eventually blowing up their account. This pattern is known as:
- Pyramiding into strength
- Averaging down into a losing position without a stop (Correct answer)
- Scaling out for risk management
- Position sizing correctly
Correct answer: Averaging down into a losing position without a stop
Repeatedly adding to a losing position without a stop-loss amplifies losses and is a leading cause of catastrophic account drawdowns.
Stock Trading Case Studies & Practical Application 5
A day trader makes 10 trades per day, each risking $50, with a 55% win rate and 1:1 reward-to-risk.
After commissions of $5 per trade, is this strategy net profitable?