Stock Trading Research & Evidence-Based Practice 2 — Questions and Answers
Question 1: Which statistical measure best describes the average annual return of a stock over multiple years when compounding is considered?
- Arithmetic mean
- Geometric mean (Correct answer)
- Median return
- Mode return
Correct answer: Geometric mean
The geometric mean accounts for compounding and provides the true average annual growth rate over multiple periods.
Question 2: What does a p-value of 0.03 indicate when backtesting a trading strategy?
- The strategy has a 3% chance of being profitable
- There is a 3% probability the results occurred by chance (Correct answer)
- The strategy outperforms the market by 3%
- The strategy failed 3% of the tested periods
Correct answer: There is a 3% probability the results occurred by chance
A p-value of 0.03 means there is only a 3% probability that the observed results are due to random chance, suggesting statistical significance.
Question 3: Which source is most likely to provide peer-reviewed empirical research on stock market anomalies?
- Reddit's WallStreetBets forum
- A broker's marketing brochure
- The Journal of Finance (Correct answer)
- A stock screener's trending page
Correct answer: The Journal of Finance
Academic journals like the Journal of Finance publish peer-reviewed research that has been vetted by experts for methodological rigor.
Question 4: What is 'data snooping bias' in the context of strategy research?
- Stealing proprietary trading data from competitors
- Finding patterns by testing so many variables that results appear significant by chance (Correct answer)
- Accessing insider information illegally
- Ignoring negative data points in a backtest
Correct answer: Finding patterns by testing so many variables that results appear significant by chance
Data snooping bias occurs when researchers test so many combinations that spurious patterns appear statistically significant purely by chance.
Question 5: Which research approach tests a trading hypothesis on data that was NOT used to develop it?
- In-sample testing
- Optimization testing
- Out-of-sample testing (Correct answer)
- Curve fitting
Correct answer: Out-of-sample testing
Out-of-sample testing validates a strategy on unseen data to confirm whether its edge holds beyond the development dataset.
Question 6: The Sharpe ratio measures a strategy's return relative to which factor?
- Maximum drawdown
- Risk-free rate and volatility (Correct answer)
- Market beta
- Transaction costs
Correct answer: Risk-free rate and volatility
The Sharpe ratio is calculated as excess return over the risk-free rate divided by the standard deviation of returns, measuring risk-adjusted performance.
Question 7: What does 'look-ahead bias' mean in backtesting research?
- Forecasting future prices using AI
- Using information in a backtest that would not have been available at the time of the trade (Correct answer)
- Overweighting recent data when modeling strategies
- Testing strategies only in bull markets
Correct answer: Using information in a backtest that would not have been available at the time of the trade
Look-ahead bias occurs when a backtest inadvertently uses future data that traders couldn't have known at the time, making results unrealistically favorable.
Stock Trading Research & Evidence-Based Practice 2
Which statistical measure best describes the average annual return of a stock over multiple years when compounding is considered?