at $52.00, trades down to $51.00, and then closes higher at$52.50. What price did you receive on your stop order? (2 pts)79. If you are using a long-term trend-following system, then you expect
your average profits to be which of the following: (a) about the sameas your average losses, (b) greater than your average losses, or (c) lessthan your average losses? (1 pt)80. When trading a stock relating to a physical market (Gold Fields and
physical gold, Oil Services and crude oil), give one positive andone negative reason for analyzing both the stock and the physicalcommodity at the same time. (3 pts)81. Why is trading futures riskier than trading stocks? (2 pts)82. Why would you choose to reverse a trade (e.g., change from long to
short) rather than simply close out your position and wait for anotheropportunity to go long? (2 pts)83. Anticipation is most important when you are doing which of the
following: (a) using a trend-following method, (b) entering a trade,(c) trading quickly, (d) expecting a price shock? (1 pt)84. At what time of day are trading signals less dependable: (a) at the
open, (b) midday, (c) at the close, or (d) just before the close?(1 pt)85. Which is not true? Your trading risk is directly related to (a) the
amount of capital in use, (b) the volatility of the stocks, (c) the amountof leverage used, or (d) the amount of diversification in your portfolio.(1 pt)86. If you discover that you are holding a losing stock position because
of an order error, it is best to do which of the following: (a) close-outthe trade as soon as possible, (b) manage the position using technicalanalysis, or (c) sue the brokerage firm because it was their error?(1 pt)
286
REVIEW QUESTIONS
87. You are long Treasury notes when the Fed unexpectedly announces that
it will cut rates by 1⁄2 point. Your best move is which of the following:(a) stay with the trade because you are on the winning side, (b) takeyour windfall profit by closing out your trade, or (c) reverse your position to take advantage of an overreaction to the news? (1 pt)88. What does the phrase “you don’t learn anything by making money”
mean? (3 pts)89. What is wrong with using the conclusions of another analyst when
deciding on your trade? (3 pts)90. The price of GOLD closed at $13.50 yesterday. You have no position
and you place an order to “Buy 1000 GOLD 14.25 stop.” The stockopens today at $14.15 and has a high of $14.90 and a low of $13.80.What is your fill? (2 pts)91. The price of MRK closed at $55.00 yesterday. You are long and want
to take profits higher. You place an order to “Sell 2000 MRK 56.60.”The stock opens at $56.90 and immediately trades down to $55.75. Itends the day with a high of $56.90 and a low of $55.50. What is yourfill? (2 pts)92. June S&P closed at 1090.00 yesterday. You are short and want to pro-
tect your profits with a stop-loss. You enter an order to “Buy 5 SPM1105.00 stop.” The market opens at 1106.50, trades down to 1102.00and closes higher at 1110.00. What is your fill? (2 pts)93. June CL closed at $24.50. You are long and place an order to “Sell 10
CLM 23.90 stop MOC.” The market opens at $24.60, has a high of$24.70, a low of $23.80, and closes at $23.95. What is your fill? (2 pts)94. When a support line is broken, what does it become? (2 pts)
Answers toChapterQuestions
Chapter 2
Charting the Trend
1. What is the reason for drawing a trendline?
To get an objective assessment of the direction of the trend.2. What is the intended relationship between interest rate changes and
stock market changes?As interest rates decline, the stock market rises.3. If you wanted to see the trend on a chart more clearly, would you use
a daily, weekly, or monthly chart? Why?A monthly chart because the trend is clearer when viewed over alonger time period, removing the noise.4. How could you have a chart where the trend was both up and down?
It can be up in the long term and down in the short term. It dependson your time frame.5. In the S&P monthly chart shown in Figure 2.12, draw the major uptrend
lines as they develop. Is there a point (or points) at which you wouldhave gone short?The first uptrend line, A, connects the low on the day after the 1987crash (point 1) with the lows at the end of 1991 (point 2). The lowof the October 1987 crash (point 1) is considered a false penetration. The second uptrend, B, connects points 2 and 3. The thirduptrend, C, is more extreme and drawn after lows at 3 and 4 are in287
288
ANSWERS TO CHAPTER QUESTIONS
place. The fourth and most extreme trendline, D, is drawn afterpoint 6 is established. Penetration of trendline C after point 6 maybe a sell signal; however, you may choose to wait for a penetrationof trendline C, which does not happen. Trendline D is then confirmed by points 7 and 8, and a sell signal comes near the top whenprices break below 1500.
Sell8D
7
Possible sell65C4
B1
2
3
A
FIGURE 2.12 The S&P futures monthly continuation series shows thesustained bull market of the 1990s and the peak in 2000.
6. Using the chart of Cisco during 1998 shown in Figure 12.3, draw the
trendlines and outline the (ideal) trades you would have made based onthe price penetration of the trend.The first trendline, A, can be drawn after the lows at 1 and 2 areestablished. At point 3 we can buy as prices come near trendline A.We redraw the trendline, B, using point 4 after the lows at points5 and 6 are set. We then get a potential sell signal after the high atpoint 7 based on a penetration of trendline B. Prices rally to point 8and we can draw the first downward trendline, C. Another sell signalcomes when prices fall through trendline A after the high at C. Atthat point the previous penetrations of trendline A appear to be afalse penetration based on extreme volatility.
289
Answers to Chapter Questions
Tren
7
dlineC8
Sell6
9
Sell
Trendline
B
5
43
1
2 Alinedne
Tr
FIGURE 2.13 Daily Cisco prices from February through October 1998. Astrong uptrend followed by a difficult, volatile period makes finding the trendlinesmore challenging but makes trading more exciting.
Chapter 3
Breakout Trends
1. What is a breakout?
A price penetration through a horizontal support or resistance line.2. Why does a breakout occur after a sideways price pattern?
Events change or there is an anticipation of events changing.3. If you buy when an upward breakout occurs, what is your initial risk in
the trade?The distance between the entry point and the support line whereyou would get a sell signal.4. What is a false breakout?
A false breakout occurs when prices penetrate the support or resistance line during the day but close inside the original support andresistance lines. A false breakout may also be one day that closesoutside the sideways range but returns to that range on the next day5. Explain when you would get a sell signal from a 20-day rolling breakout.
290
ANSWERS TO CHAPTER QUESTIONS
When prices close below the 20-day low. If you are using an intradaybreakout, it’s when the low of today is below the low of the previous20 days.6. Explain why a technical trader might choose to use an N-day breakout
instead of drawing classic trendlines on a chart.An N-day breakout is well-defined and can be tested historically.It can be calculated quickly using a spreadsheet; therefore, itwill allow you to trade more stocks or other markets for addeddiversification.7. How would you combine a penetration of a classic downward trendline
with a breakout method?You would wait after the downward trendline is broken by anupward price move, identify the next sideways pattern or the nexthigher resistance level from which you would draw a horizontalresistance line, and then buy when that resistance line is brokenby an upward price move.8. Is the distribution of the length of trends random?
No. There are more trends that are of longer length than expected ina normal distribution. The distribution of trend lengths has a fat tail.
Chapter 4
Calculating the Trend
1. Using the following S&P index prices from November 2002:
908.35, 915.36, 923.76, 902.57, 894.73, 876.19, 882.95, 882.53, 904.27,909.81, 900.36, 896.74, 914.15, 933.79, 930.55, 932.87, 913.31, 938.87,936.31, 934.53(a) What are the last three values of a 10-day moving average?(b) Is the trend going up or down?(c) What would be the next price in order to change the direction of thetrend?(a) The last three values of the 10-day average are 917.472, 920.676,and 923.148(b) The trend is up.(c) Any price lower than 923.16 will turn the trend down.
Answers to Chapter Questions
291
2. Which trend will change direction first—a 10-day moving average or a
20-day moving average?The 10-day moving average.3. With percentage smoothing, the most recent price changes are given
(a) less importance, (b) the same importance or (c) more importancethan previous price changes?(c) More importance.4. If today’s closing price is $50, yesterday’s trendline value was $40, and
you are using a percentage smoothing of 10 percent, what is today’strendline value?$41.5. When the slope of a regression line is greater than zero, are prices
rising or falling?Rising.6. What is the daily slope of a regression line that rises 10 points in
5 days?2.7. When the slope values today and yesterday are both 1.5, are prices
rising, unchanged, or falling?Rising.8. If yesterday’s slope value was 1.5 and today’s slope value is 1.0, are
prices rising, unchanged, or falling?Rising at a slower rate.9. Using a moving average to trade, when do you get a buy signal? A sell
signal?You buy when the trendline turns up and sell when the trendlineturns down.10. Using a breakout system, the previous 10-day high was $30.50 and
the previous 10-day low was $28.50. Prices break out to the upsideand you buy 100 shares at $31.00. What is the risk of your tradein dollars?$250, the distance from your entry to the breakout low price.
292
ANSWERS TO CHAPTER QUESTIONS
11. Which of the four trending methods, moving average, smoothing,
breakout, or slope,(a) Is usually most reliable?(b) Has the smallest losses?(c) Has the largest losses?(a) Breakout, (b) moving average and smoothing, (c) breakoutand slope.12. If the moving average method produced good profits when you
checked its performance on the history of IBM, but none of the othertrending methods were profitable, would you trade IBM using themoving average? Why?No. To have high confidence in a trending method, all the trendingtechniques should work.13. You’ve just read an advertisement for a trend system that has 80 percent
profitable trades and very low risk. What’s wrong with that statement?A trend system has two profiles, one with small losses (small risk)and a small percentage of profitable trades, the other with largelosses and a large percentage of profitable trades. There is no trending system that has mostly profits and low risk. You also may question the number of trades in the results (5 or 500?), the total timeperiod of performance (one week or 10 years?), and whether theperformance was generated by a computer or was the result ofactual trading.
Chapter 5
The Trading Game
1. Why do you want to choose at least three stocks from three
different market sectors?For diversification.2. In the price shock of 9/11, which way did GM move and which way did
Raytheon move? Why?GM fell and Raytheon rose. Raytheon is a defense contractor andwould immediately benefit from any antiterrorist policies.3. If the price of Amazon.com is $10 and you wanted to go long 100
shares at $12, what order would you place?Buy 100 AMZN 12 stop.
Answers to Chapter Questions
293
4. IBM is trading at $38. You own 500 shares at $40 and want to buy an
equal amount if it drops to $36. What order do you place?Buy 500 IBM 38.5. You want to buy 250 shares of GE if it rises to $45 and closes above that
level. What order do you place?Buy 250 GE 45 stop MOC.6. The December S&P futures contract has been in a narrow, sideways
range for three weeks, trading from 950 to 990; therefore, you want togo long above 990 or short below 950 to take advantage of any newdirection. What order do you place?Buy 1 SPZ 991 stop OCO Sell 1 SPZ 949 stop.7. You bought 200 GE at $30 and the price is now $28. What is your profit
or loss?$400 loss.8. You sold 1 contract of TYZ at 108-16 and the price is now 108-00. What
is your profit or loss?$500 profit.
Chapter 6
Channels and Bands
1. Once you’ve drawn an upward trendline, how do you draw the upward
channel line?The upward channel line is drawn parallel to the trendline using thehighest high price between the points used to draw the trendline.2. When would you redraw the upward channel line? What point would
you use to redraw it?You redraw the upward channel line after a significant penetrationof the previous channel line, and two or three days following thepenetration to be sure that it was not a false breakout. You usethe new highest high to draw the new channel line parallel to theoriginal trendline3. If you are trading a channel, where would you buy and where would
you sell?Buy in the lower 20 to 25 percent of the channel, and sell in theupper 20 to 25 percent of the channel.
294
ANSWERS TO CHAPTER QUESTIONS
4. If you’ve bought near the bottom of the channel, where are the two
places you would exit the trade?Take profits in the upper zone, and take a loss if prices penetratethe upward trendline heading lower.5. If prices move above the channel line for only one day, and then fall
back below the channel line, explain why you would or would notredraw the channel line.You may redraw it because the penetration shows that volatilityis increasing; you may not redraw the channel line becausethe price reversal indicates a false breakout that may be drivenby a one-time news event.6. How do you construct a 3 percent band around a 10-day moving average?
You multiply the moving average value by 1.03 to get theupper band and divide the moving average value by 1.03 toget the lower band.7. How would you trade a percentage band?
In the same way as any other channel, selling in the upper zone andbuying in the lower zone8. What are two advantages of Bollinger bands over percentage bands?
(a) They adapt quickly to changes in volatility.(b) They represent specific confidence levels. You can expect5 percent of the highs and lows to penetrate the bands.9. If prices penetrate through a 5 percent band too often, what can you do?
Increase the size of the band.10. What are two disadvantages of a larger band?
Higher risk and fewer trades.11. When does profit-taking work best? Anytime you have more than a
10 percent profit, in a noisy market, or as a long-term trend follower?In a noisy market. Profit-taking should be based on pricevolatility, or support and resistance levels; therefore, 10 percentis arbitrary. Long-term trend followers cannot take profitsbecause they need the few, very large profits to offset manylosses.
Answers to Chapter Questions
Chapter 7
295
Event-Driven Trends
1. What is the key element that distinguishes a moving average trend from
a swing trend?The moving average is time-driven; a swing is event-driven. A swinghas no time element.2. If the swing direction is up, the high price is $50, and you are using a
3 percent swing value, at what price would the swing direction turndown?$48.50.3. If prices make a swing high of $30, a swing low of $25, and a swing high
of $31, at what price would you get a swing sell signal?Below $25.00.4. Would you get more point-and-figure signals using a box size of $1 or 50¢?
50¢.5. If you had a point-and-figure box size of $1, and prices have just
declined from $48.00 to $41.50, at what price would you begin a newcolumn of X’s.$45.00.6. Using a $1 box size, we plot a column of X’s with the highest box filled
at $28, followed by a new column of O’s and then another column ofX’s. What is the lowest price that would give you a buy signal?$29.00.
Chapter 8
Controlling the Risk of a Trade
1. The best place for a stop-loss is (a) as close as possible, (b) based on
how much you can afford to lose, or (c) a support or resistance level.(c) A support or resistance level.2. What is the closest point at which you would place a stop-loss order? Why?
About 11⁄2 times the daily volatility; otherwise, you are likely toalways get stopped out due to market noise, even when the trenddoesn’t change.3. When you enter a new long position, where would you place your initial
stop-loss?At the point where you would get a sell signal.
296
ANSWERS TO CHAPTER QUESTIONS
4. If you have just entered a long position, when would you raise your
stop-loss for the first time?Following a new high (secondary buy signal) a pullback that formsa new, higher support level. The new support level becomes yourstop-loss point.5. What is the advantage of using a stop close-only order on your long
position?The stop is not executed unless prices close below the stop-losslevel. It prevents exiting on a false breakout to the downside.6. Why would you use a fast and a slow trend instead of just a slow trend?
The combination has smaller risk, and smaller profits, but the netresult could be as good as a single trend.7. If you’ve placed your stop-loss at $35 for your long position (entered at
$40) and a price shock causes a sudden, large drop to $25, what are youlikely to get as your exit price?$25.
Chapter 9
One-Day Chart Patterns and Reversals
1. Define an upward gap.
The low of the day is greater than the high of the previous day.2. When is a gap most likely to occur?
When a news release occurs after the market is closed, the gapoccurs on the next open.3. Name four gaps most often found on a chart. Briefly explain how to
recognize each.(a) A common gap occurs most often and may be found within acluster of price activity. It does not have any special featuresother than the gap from the previous day.(b) A breakaway gap (up) occurs when prices jump out of a tradingrange or another formation, such as a descending triangle.Prices do not retrace back into the previous pattern.(c) A runaway gap occurs in the middle of a trend and is seen as anacceleration of the current trend.(d) An exhaustion gap occurs just after the top of a steep move andusually marks the end of the current trend.
Answers to Chapter Questions
297
4. If today’s price action is much more volatile than the previous month
and the high is much higher than the high of the same period, would wecall the pattern a spike or a wide-ranging day?A wide-ranging day because we need to see the next day trade muchlower to be a spike, but any exceptionally volatile day can be a wideranging day.5. Define an island reversal bottom.
A cluster of days separated by a gap down at the beginning and agap up at the end, where the body of the “island” is below the previous and subsequent price movement.6. When are reversal patterns most reliable? (a) After a sustained move in
one direction, or (b) after a highly volatile move?(a) After a sustained move in one direction.7. Why would a five-day run day pattern be considered not timely for trading?
Because you need to wait five days after it occurs to identify the pattern.8. After a sustained upward price move, there are two inside days. What
does this tell you?It shows a drop in volatility that indicates a lack of direction. Theevent that caused the upward move is over. If nothing new happensto stimulate a continuation of the upward move, expect a reversal.
Chapter 10
Continuation Patterns
1. How does a continuation pattern help you trade?
It confirms the direction of the trend.2. At what points in a trend is a symmetric triangle most likely to occur?
At the beginning and end, where the direction of the trend is uncertain.3. Which triangle is most likely to occur in the middle of an upward trend,
a symmetric, ascending, or descending triangle?Ascending, it leans in the direction of the trend.4. Describe a flag in an uptrend.
It is a downward-leaning formation bounded by two parallel lines.5. What is the difference between a pennant and a triangle?
298
ANSWERS TO CHAPTER QUESTIONS
A pennant is an irregular formation. It does not have a horizontalsupport or resistance line, nor is it symmetrical.6. During a downtrend, which way does a wedge point?
Down.7. What should you do if a descending triangle is formed during
an uptrend?Exit your long position. The upward trend is likely to be over.
Chapter 11
Top and Bottom Formations
1. True or false? It is best to sell a “V” top on the day it makes its spike at
the top of the move?False. You don’t know that it’s a “V” top until one or two days afterthe spike.2. Define an island top.
A formation at the top of a run that begins with a gap up and endswith a gap down.3. Which is riskier to trade, (a) selling a double top or (b) buying a double
bottom?(a) Selling a double top because prices tend to be very volatile.Double bottoms can occur in much quieter trading.4. The price of a stock falls through support at $30, and then forms a double
bottom with a low of $21. After better economic news, prices rally andbreak through resistance at $30. You buy. What is your price objective?$39.5. If the volatility of a double top was $10 and prices moved through sup-
port at $40, the point where the double top was confirmed, what wouldbe your maximum profit target? What would be a more realistic targetand why?$30. A more realistic target would be $32.50, because volatility willdecline as prices fall.6. Describe the classic calculation for a head-and-shoulders top profit target.
The distance between the neckline and the top of the head projecteddownward from the point where prices break the neckline after theright shoulder is formed.
Answers to Chapter Questions
Chapter 12and Gann
299
Retracements, Reversals, Fibonacci Numbers,
1. What are the three most likely percentage retracement levels?
100 percent, 50 percent, and 61.8 percent.2. What significance would you put on a 100 percent retracement?
The reason for the prior move had disappeared.3. Write the first six numbers of the Fibonacci summation series.
1, 1, 2, 3, 5, 8, 13.4. In the Fibonacci summation series, for large numbers in the series, what
is the ratio of the Nth value to the previous value?1.618.5. If prices moved from a low of $35 to a high of $55, then retraced to $45,
and started to move higher, a Fibonacci ratio of .618 would tell you toexpect prices to reach what level?$57.36.6. If a high occurred on December 4, a low 20 days later, and another high
15 days after the low, in how many days would you expect a new highor low according to the Fibonacci ratio .618?About 22 days later.7. In a Gann square, the key support and resistance levels are supposed to
fall where?On the horizontal, vertical, and diagonal lines crossing through thecenter of the square.8. As you move outward in Gann’s square or hexagon, the various support
and resistance levels represent (a) an increase in, (b) unchanged, or(c) a decrease in volatility?(a) An increase.
Chapter 13
Volume, Breadth, and Open Interest
1. What interpretation do you place on falling prices and falling volume?
It is a weak downward trend, not heavily supported by traders.
300
ANSWERS TO CHAPTER QUESTIONS
2. Would you say that volume trends are (a) clear and easy to interpret or
(b) require smoothing to avoid erratic values?(b) Require smoothing to avoid erratic values.3. If volume was high and prices closed unchanged, would you consider
the risk of trading (a) low, (b) normal, or (c) high?(c) High.4. A volume spike usually corresponds with what price pattern?
A local top or bottom.5. How do you calculate On-Balance Volume?
If prices are higher, add the total volume; if prices are lower, subtract the total volume.6. Of all the volume patterns and indicators, which appears to be the most
definitive?The volume spike.7. If prices are falling, what would the market breadth need to do in order
to confirm the decline?Fall.8. In futures trading, if a new buyer meets an old seller, what happens to
the open interest?It remains unchanged.
Chapter 14
Momentum and MACD
1. If the last five prices of IBM were $40.25, $40.75, $41.25, $40.75, and
$41.50, what is the value of the five-day momentum?1.25.2. Which one of the 20-day or 40-day momentum lines can potentially have
the highest value?40-day.3. When two consecutive momentum values are 1.50 and 1.50, are prices
(a) increasing, (b) unchanged, or (c) decreasing?(a) Increasing.
Answers to Chapter Questions
301
4. When two consecutive momentum values are 2.50 and 1.50, are prices
(a) increasing, (b) unchanged, or (c) decreasing?(a) Increasing but at a slower rate.5. If you are using momentum as a trend indicator, at what point does the
trend turn up?When the momentum value crosses zero going up.6. If you are using the MACD as a trending indicator, when do you get a
sell signal?When the MACD crosses the slower signal line heading down.7. How would you improve the reliability of a standard MACD trending
sell signal?By selecting only those sell signals above a minimum MACD value.8. Describe an MACD bearish divergence.
Two consecutive price peaks are rising, while the two correspondingMACD peaks are declining.9. What would make you consider one bullish divergence as stronger
than another?The stronger one has prices declining further and/or the MACD lowpoints rising more than the other.10. If you were anticipating a bearish divergence and planned to make
two sales, when would you sell?(a) When prices made a new high and the MACD was lower.(b) When the second MACD high comes within 10 to 15 percent ofthe previous MACD high while prices are above the previousprice peak.
Chapter 15 Overbought/Oversold Indicators andDouble Smoothing1. When contrary opinion indicates that the market is oversold, do you
(a) buy immediately, (b) sell immediately, (c) use a timing indicator togive you a specific buy signal, or (d) use a timing indicator to give youa specific sell signal?(c) Use a time indicator to give you a specific buy signal.
302
ANSWERS TO CHAPTER QUESTIONS
2. What is the greatest disadvantage of the Bullish Consensus indicator?
It is not timely.3. Explain the raw stochastic in words.
It is the position within the recent high-low range, expressed as apercentage of the range relative to the lowest price of the range.4. Name the three stochastic calculations from fastest to slowest.
The raw stochastic, %K, the three-day smoothing of %K called %Kslow or %D, and the three-day smoothing of %D called %D-slow.5. What is the primary difference between the stochastic calculation and
momentum values?The stochastic is scaled between 0 and 100. The momentum values canbe as large as the greatest price move within the calculation period.6. Explain the chart pattern that gives you a bullish stochastic divergence
signal.Two consecutive price lows are declining, and the two corresponding stochastic values are rising. The first crossing of the faster andslower stochastic upward, after the divergence formation, will give abuy signal.7. In a stochastic bearish divergence, the second stochastic peak should
be lower than the first by at least what value?5 percent.8. The Relative Strength Index is a ratio of what two values?
The sum of the upward price changes divided by the sum of thedownward price changes over the same time interval.9. Explain the steps need to create a double-smoothed trendline using a
10-day momentum.(a) Create the 10-day momentum.(b) Sm