Stock Trading Research & Evidence-Based Practice 4 — Questions and Answers
Question 1: Which type of research study design provides the strongest causal evidence for a trading strategy's effectiveness?
- Anecdotal case study
- Randomized controlled experiment on live trading accounts (Correct answer)
- Correlation analysis of two variables
- Expert opinion from a successful trader
Correct answer: Randomized controlled experiment on live trading accounts
A randomized controlled experiment isolates causation by randomly assigning conditions, making it the gold standard for causal inference in empirical research.
Question 2: A stock's R-squared value of 0.85 against the S&P 500 indicates that:
- The stock outperforms the S&P 500 85% of the time
- 85% of the stock's price variance is explained by movements in the S&P 500 (Correct answer)
- The stock has a beta of 0.85
- The stock correlates negatively with the index 85% of the time
Correct answer: 85% of the stock's price variance is explained by movements in the S&P 500
R-squared measures the proportion of a security's variance explained by the benchmark; 0.85 means 85% of its movement is attributable to the index.
Question 3: What is 'publication bias' and how does it affect trading strategy research?
- The tendency for journals to publish only strategies with positive results, overstating their prevalence (Correct answer)
- The preference of traders to publish on social media instead of academic journals
- The delay between discovering and publishing a strategy
- The requirement to disclose profitable strategies to the SEC
Correct answer: The tendency for journals to publish only strategies with positive results, overstating their prevalence
Publication bias skews research because journals favor statistically significant positive findings, making trading edges appear more common than they truly are.
Question 4: Which of the following is an example of anchoring bias in stock research?
- Selling a stock as soon as it returns to the original purchase price (Correct answer)
- Diversifying across sectors based on correlation data
- Revising a price target after reviewing updated earnings guidance
- Using a discounted cash flow model to set a fair value
Correct answer: Selling a stock as soon as it returns to the original purchase price
Anchoring bias causes investors to fixate on the purchase price as a reference point, leading to irrational decisions like waiting for break-even before selling.
Question 5: What does the January Effect research anomaly suggest about small-cap stock returns?
- Small-cap stocks consistently underperform in January due to tax-loss selling rebounds
- Small-cap stocks tend to outperform in January, possibly due to tax-loss selling reversals in December (Correct answer)
- Large-cap stocks dominate returns in January
- The effect has been proven to persist reliably after its discovery
Correct answer: Small-cap stocks tend to outperform in January, possibly due to tax-loss selling reversals in December
The January Effect describes the historical tendency for small-cap stocks to outperform in January, often attributed to buying pressure after December tax-loss selling.
Question 6: A trader cites a study with a sample size of 12 trades to justify a strategy. What is the main methodological concern?
- The trades should have been executed in a paper account
- A sample of 12 is too small to draw statistically reliable conclusions (Correct answer)
- The study should use daily instead of weekly data
- The researcher should have used a different brokerage
Correct answer: A sample of 12 is too small to draw statistically reliable conclusions
A sample size of 12 provides insufficient statistical power, meaning results could easily be due to chance rather than a genuine edge.
Question 7: Which tool allows traders to screen stocks using fundamental and technical criteria simultaneously to generate a research starting universe?
- A stock screener (Correct answer)
- A limit order book
- A dark pool
- An options chain
Correct answer: A stock screener
Stock screeners filter the entire market using criteria such as P/E ratio, revenue growth, moving averages, and volume to narrow down candidates for deeper research.
Stock Trading Research & Evidence-Based Practice 4
Which type of research study design provides the strongest causal evidence for a trading strategy's effectiveness?