increases, punctuated by sharp declines?1. Carrying charges2. Manipulation3. Seasonal factors4. Cost of substitutionQuestion 105—Writing OptionsWhat is the main reason that options writing is much more profitablethan buying?1. The time value of options2. Most buyers are undercapitalized.3. Options move differently than stocks.4. Most buyers are beginners.
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Question 106—Writing Covered OptionsWhat is the main disadvantage of writing covered options?1. If the stock stays flat, you will have no capital gain in it.2. If the stock falls, your long position will lose value.3. If the stock rises above the exercise price, it will be called away.4. Covered writing requires large capital.Question 107—Naked vs. Covered WritingWhat is the main difference between naked and covered optionswriting?1. Trade duration2. How the trades are backed3. Trade size4. The analytic techniquesQuestion 108—The Demands of Naked WritingThe greatest demand that naked writing of options places on traders is:1. Cash2. Trading ideas3. Discipline4. TimingQuestion 109—Brokers Against TradersIn the following list of venues for trading forex, where does a broker’sprofit usually depend on a trader’s loss?1. The interbank market2. Currency futures3. Holding foreign cash4. Forex trading houses
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Question 110—Forex MarketWhich of the following does not apply to the forex market?1. It is one of the most trending markets on a long-term basis.2. It is largely driven by the fundamentals of government policies.3. It is easy to plan and enter trades in forex.4. It trades essentially 24/7.Question 111—Learning to Become a Better TraderThe most important factor in learning to become a better trader is:1. Researching the market2. Keeping good records3. Finessing your entry and exit techniques4. Luck
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Question 112—Trading Signals of Force Index
Figure 3.112
On the chart above, you can see that the downspikes of Force Index(marked by solid arrows) tend to be followed by price bottoms thefollowing day. The chart also shows that the upspikes of Force Index(marked by dashed arrows) tend to be followed by the continuation ofthe uptrend rather than a top. These differences indicate that:1. This indicator works only in downtrends.2. This indicator works only in uptrends.3. Uptrends and downtrends are not symmetrical and have to be tradeddifferently.4. One can base a trade on a single indicator in a bear market.
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Question 113—False Breakouts and Divergences
1A
B
C
D
E
Figure 3.113
Please match the letters on the chart to the following descriptions:1. False breakouts2. Divergences
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Question 114—Shorting and Covering SignalsB
DEGI
A
K
FHC
J
L
Figure 3.114
Please match the letters on the chart to the following descriptions:1. Pullbacks to value2. Undervalued zone3. Kangaroo tails4. Divergences
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Question 115—Shorting Tactics
Figure 3.115
Please select the tactic to follow for the next few weeks at the rightedge of the chart:1. The trend is up—buy here, near $94.95.2. The trend is up—buy on a breakout above the recent peak of$100.50.3. The Impulse system turned Blue with the downtick of MACD—sellshort, with the target of $87, near the fast EMA.4. The Impulse system turned Blue—sell short with a target of $81,near the slow EMA.
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Question 1—The Stress of Holding a PositionHaving bought a stock, most people find themselves in the least stressful position if that stock:1. Rises slightly2. Skyrockets3. Declines slightly4. CollapsesAnswer: 3Sitting back and doing nothing feels easy; thinking and making decisions is hard. While a collapse in your stock feels painful, the rise isalso stressful because it forces you to think about your exit strategy,targets, stops, and so on. Most people are surprisingly comfortable sitting with a slightly losing position and hoping for better.Question 2—Your Trading EdgeYour trading edge can come from:1. Fundamental analysis2. Technical studies3. Discipline4. All of the aboveAnswer: 4
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An edge is a method of discovering opportunities and placing ordersthat gives a trader an advantage over the majority of competitors. Atrader with either a technical or a fundamental edge still needs discipline to implement trading signals.Question 3—The Three Great DividesThe three great divides in trading include all of the following, except:1. Technical vs. fundamental research2. Trend vs. counter-trend trading3. Relying on TV news vs. an advisory service4. Discretionary vs. systematic tradingAnswer: 3A serious trader needs to specialize by choosing those areas ofresearch and trading that appeal to him. Choosing between technicalor fundamental analysis, trend or counter-trend trading, and discretionary or systematic trading are all serious choices. Your selectionsdepend to a great degree on your temperament and personality. A successful trader is an independent person. Hooking yourself up to thefeeding line of either TV news or an advisory service is really no choiceat all, since there is so little difference between them.Question 4—Price and ValueFind the incorrect statement about the relationship between price andvalue:1. Values change slowly, prices change fast.2. Studying earnings reports and industry trends allows you to discovervalue.3. Moving averages help define the value zone by tracking publicconsensus.4. Price equals value at any given moment.Answer: 4Prices are easily seen while you need to look for values. Prices canchange quickly in response to the mood of the masses, while valueschange slowly. Each price is a momentary consensus of value, but that
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consensus keeps changing, overshooting value on the way up or down.A simple tool, such as a pair of moving averages, helps you get a general idea of where the value is and which way it is moving—and allowsyou to trade accordingly.Question 5—Fundamental and Technical AnalysisWhich of the following statements about fundamental and technicalanalysis is incorrect?1. A fundamentalist calculates the value of the business that issued astock.2. Having precise information about the fundamentals tells you exactlywhich way a stock is going to go.3. A technician looks for repetitive patterns in price data.4. A pure technician does not care about earnings or corporate news;he only wants to know the stock ticker and price history.Answer: 2Having precise information about the fundamentals does not forecast exactly which way a stock is going to go. The problem with fundamental analysis is that values change slowly but prices fluctuate fast.In the short run, prices can even move against the fundamentals.Whether you are primarily a fundamentalist or a technician, you wantto know how the other side lives and thinks. Having both a fundamental and a technical view of a stock provides a deeper understanding of its trends and reversals.Question 6—Trend vs. Counter-Trend TradingAll of the following are advantages of trend trading over counter-trendtrading, except:1. Greater profit potential per trade2. Lower commission expense3. More time to make decisions4. Lower stress levelAnswer: 4
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Trend trades last longer than counter-trend moves, giving you moretime to make trade-related decisions. They promise greater profits bycovering longer distances. Commissions are lower in trend-followingtrades than in active swing trading. Still, it would be incorrect to expecta lower stress level. Riding a trend is like riding a bucking horse thattries to shake you off. Holding on to a trend-following trade requiresa great deal of patience and self-assurance—a lot of mental work.Question 7—System vs. Discretionary TradingSystem trading has all of the following advantages over discretionarytrading, except:1. Knowing in advance what profits or losses to expect over a periodof time2. Less emotional involvement in every trade3. A greater degree of freedom4. A method for handling the uncertainty of the marketsAnswer: 3System traders who have done a lot of backtesting can have a fairlyhigh level of confidence knowing what profits or losses to expectdown the road. If they have the discipline to follow all the signals oftheir system, they will lower their stress level, insulating themselves toa degree from uncertainty in the markets. What they give up is the freedom to make decisions as market conditions change and create newthreats or opportunities.Question 8—Technical ToolboxA technical trader uses a toolbox of indicators in his or her decisionmaking. Find the correct statement among the following:1. Selecting the tools that give the signals you want is a sound practice.2. The more tools, the better the toolbox.3. “Five bullets to a clip” allows you to use only five indicators.4. The best indicators are well known, and a trader should use them.Answer: 3A typical beginners’ mistake is to overstuff their toolbox; they alsotend to use different tools at different times to confirm their precon-
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ceptions. It is much better to limit yourself to a small number of welltested tools. Which tools are used, however, may very well vary amongdifferent traders.Question 9—New High–New Low IndexFind the incorrect statement about the New High–New Low Index:1. NH-NL confirms uptrends by reaching new highs; it confirms downtrends by falling to new lows.2. The signals of NH-NL are symmetrical at tops and bottoms.3. Bearish divergences of NH-NL warn of impending market tops.4. Downspikes of NH-NL often identify important market bottoms.Answer: 2NH-NL may be the best leading indicator of the stock market, but itbehaves differently at tops and bottoms. The emotions of the marketcrowds are different in those areas. Tops are formed by greed whichtends to last a lot longer than fear, the dominant emotion at marketbottoms. This is why the best signals of the tops are longer-lastingdivergences, while the best signals of the bottoms are brief and violentdownspikes.Question 10—Trading PsychologyFind the incorrect statement about trading psychology:1. If you set your technical system just right, you need not worry aboutpsychology.2. The mind of a trader continually filters the incoming information.3. Wishful thinking causes traders to “see” non-existent technical signals.4. A bullish trader is more likely to overlook sell signals.Answer: 1The sheer volume of information available to us is so immense thatno human can process everything. Our eyes, ears, and brains filter outmuch of incoming data. We become consciously aware of only a smallpart of market information. Our wishes, hopes, and fears filter out muchof the rest. Trading systems have their advantages, but it would be ahumanly impossible task to switch off our personal psychology, in themarkets or anywhere else.
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Question 11—Trading DisciplineTraders need discipline because the markets present an endless paradeof temptations. Please identify the incorrect statement among thefollowing:1. People with a history of poor impulse control are likely to fail intrading.2. AA (Alcoholics Anonymous) provides a useful model for dealingwith market temptations.3. If you have a good trading system, discipline is not really an issue.4. Some traders have personality flaws that make them destined to fail.Answer: 3The seemingly easy riches that glitter on every screen seduce manytraders to plunge into the market without considering its very real dangers. You need discipline to set up and follow your decision-makingtree. You must decide when to step in and when to stay out. Peoplewho cannot resist temptation are likely to do poorly in trading, no matter how smart they are.Question 12—Dealing with LossesMany traders feel ashamed of their losses. Please review the followingstatements and find the correct one:1. In training, punishments are more effective than rewards.2. If you have taken several right steps and one wrong one in makinga trade, you should punish yourself for it.3. Successful traders love the game more than the profits.4. It does not pay to keep records of losing trades.Answer: 3Rewarding people tends to improve their performance much morethan punishments. It pays to be kind to yourself while learning how totrade. Give yourself sufficient time to learn; celebrate even partial successes. Keep good notes of all your trades—you will probably learnmore from losses than from wins. Trade a small size, so that you canfocus on the game and not on the money. You can always increase yourtrading size later, after you become more knowledgeable and secure.
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Question 13—OvertradingTrading a position that is too large for one’s account will lead to all ofthe following, except:1. Less spontaneity and greater stiffness2. Less calm and adaptability3. Fear of pulling the trigger4. A greater focus on the marketAnswer: 4When stakes become dangerously high, people become stiff withtension and are afraid to pull the trigger. The spontaneity and ease ofadjustment deteriorate, and performance goes down accordingly. Atrader whose position is too large for his account is not focusing on themarket. He is focusing on the money. The feeling of tension clouds hismind, preventing him from reading the market’s signals. One of thekey goals of money management is to put your mind at ease by setting realistic position limits and providing a safety net for your account.Question 14—The 2% RuleA beginning trader with a $20,000 account decides to implement the2% Rule of money management. He finds a stock quoted at $12.50 anddecides to buy it, with a price target of $15 and a stop-loss order at$11.50. The maximum number of shares this Rule allows him to buy isclose to:1. 9002. 4003. 3504. 200Answer: 3A trader who decides to risk no more than 2% of his account in anygiven trade may risk the maximum of $400 in a $20,000 account. Ofcourse, he is free to risk less. Buying a stock at $12.50 and putting astop at $11.50 means risking $1 per share. In a perfect world, this rulewould have allowed him to buy 400 shares, but in reality this traderwill have to pay a commission when he buys and again when he sells;
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he can also expect to be hit with slippage. This is why 350 shares isthe correct answer. He may buy even fewer shares but he may not buya greater number.Question 15—Modifying the 2% RuleAn experienced trader with a $2,000,000 account decides to modify the2% Rule and cap his risk per trade at 0.25%. He finds a $9 stock whichhe plans to ride to $12, while putting his stop at $8. The maximumnumber of shares his Rule allows him to buy is:1. 2,0002. 4,5003. 5,0004. 12,000Answer: 2As a rule, the larger the account, the lower the percentage a traderwill risk on any single trade. The maximum for him is the same as foreveryone else—2%; still, he may go up to that absolute limit only whenhe sees an exceptional opportunity. At other times he is likely to limithis risk to well below 1%. For a trader with a $2,000,000 account, aquarter percent comes to $5,000—quite a bit to bet on a single trade.Risking $1 per share means a theoretical maximum size of 5,000 shares.In practice, the size has to be reduced, to pay commissions and tocover possible slippage.Question 16—The 6% RuleFind the statement about the 6% Rule that is correct:1. It will protect your account from a drawdown caused by a bad trade.2. It will protect your account from a drawdown caused by a series ofbad trades.3. When losses begin to mount, the best response is to trade moreactively, to trade your way out of a hole.4. The 6% Rule needs to be applied after putting on a trade.Answer: 2
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The 2% Rule is designed to limit risk on any single trade, but the 6%Rule will protect you from the damage caused by a series of bad trades.The 6% Rule will force you to step back when losses begin to mount;this is the opposite of what most traders do, as they dig themselves adeeper hole by frantic trading. The time to apply the 6% Rule is beforeyou enter a trade, not after. It helps you to see whether you can affordthe risk of an additional trade.Question 17—The Top Two Goals for Every TradeWhat are the top two goals for every trade?1. Make money and test a new system.2. Face the challenge and feel the joy of victory.3. Make money and become a better trader.4. Test your discipline and the ability to implement a plan.Answer: 3The main reason to trade is to make money, but there is a fair bit ofrandomness in the markets, and not every trade can be profitable. Onthe other hand, becoming a better trader is a very reachable goal forevery trade. Whether you win or lose, you must become a better traderat the conclusion of each trade. You must keep learning both from yourwinning and losing trades. Testing your discipline and the ability toimplement a plan are key components of learning to become a bettertrader.Question 18—Learning from ExperienceThe best way to learn from experience is:1. To make lots of trades2. To keep good records3. To discuss your trades with friends4. To review your brokerage statementsAnswer: 2
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A human mind has a limited capacity to remember. Keeping goodrecords allows you to transform fleeting experiences into solid memories.Using your notes as your “extracranial memory” allows you to re-examineyour experiences and grow into a better trader. A trader who uses moneymanagement rules to protect his equity and who keeps good recordsto learn from his experience is on the road to success.Question 19—A Record-Keeping SpreadsheetWhich of the following must be included in a basic record-keepingspreadsheet?A. Gross and net P&LB. The grade of each tradeC. Slippage on entry and exitD. Source of every trade idea1. A2. A and B3. A, B, and C4. All of aboveAnswer: 4The purpose of keeping a trader’s spreadsheet is to record hard factsabout your trading. In addition to such basic data as entry and exitprices, you need to calculate slippage, track the quality of your sources,and grade your performance for every entry and exit, as well as foreach trade.Question 20—Trading MistakesWhich of the following statements about trading mistakes is incorrect?1. Intelligent people do not make mistakes.2. Making mistakes is inevitable when you learn and explore.3. Repeating mistakes is a sign of impulsivity.4. Keeping a diary helps you learn from your mistakes.Answer: 1
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Mistakes are part and parcel of learning and exploring—which iswhy intelligent people often make them. There is nothing wrong withmaking a mistake—the problem is repeating the same mistake. Keeping a diary helps you avoid this problem.Question 21—Trader’s DiaryFind the correct statement about the Trader’s Diary:1. There is no need to rush documenting your entry if you plan to fillin the diary after you exit.2. The diaries of losing trades tend to be more valuable than those ofwinning ones.3. It is essential to create diary entries only for your best trades.4. An active trader who cannot document all trades can pick andchoose what trades to document.Answer: 2Losses force traders to stretch their minds and learn new things. It isimportant to study all aspects of a trade and document your entrywhile the details are still fresh in your mind. An active trader who canrecord only some trades needs a disciplined system, such as recordingevery second, fifth, or even tenth trade, regardless of whether thattrade was a winner or a loser.Question 22—Diary EntryThe diary of an entry into a trade must include all of the following,except:1. The reason for making this trade2. The buy grade for long or sell grade for short trades3. Charts of your trading vehicle at the time of the entry4. The trade gradeAnswer: 4
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You want to record your reason for entering a trade to help you discover which signals produce better results. It pays to analyze any market in more than one timeframe: one longer-term, another shorter-term,for a deeper understanding of what is happening. If you follow thisrule, you will need to save entry charts in more than one timeframe.While you must rate your entry at the end of the day, you won’t knowyour overall trade grade until you close it out.Question 23—Trading Plan vs. DiaryWhich of the following describes the difference between a Trader’sDiary and a Trading Plan?1. Contains charts in two timeframes.2. The charts are marked up to identify buy or sell signals.3. The document is named after the stock ticker.4. Buy or sell grades are recorded.Answer: 4A trading plan uses the same format as the diary. It shows charts inmultiple timeframes, marked up with trade signals. They are named inthe same way, even though their labels are different. The one difference is that a trading plan cannot include buy or sell grades—you willknow them only after you put on a trade.Question 24—The Monitoring ScreenThe window for monitoring stocks in your trading software shouldinclude all of the following, except:1. Key market indexes2. Your open positions3. The stocks you consider trading4. The stocks you have exitedAnswer: 4It is essential to monitor your open positions, whether long or short.It is also important to keep an eye on key market indexes, such as theDow or the Nasdaq. Needless to say, you want to keep a short list ofstocks you are thinking of trading on the front burner. The stocks you
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have exited would only clutter your screen. If you do not plan to reenter them any time soon, move them to a separate window or tab.Question 25—Comments on the ScreenKeeping your comments about your open positions on the screen isuseful for all of the following reasons, except:1. It reminds you how long you have been in a trade.2. It helps you see whether you are winning or losing in an openposition.3. It helps you keep track of your profit target and stop-loss order.4. It helps you measure your performance.Answer: 4If your trading software allows you to write on the screen, takeadvantage of this feature. Marking your entry date and price will helpyou see at a glance where you stand in that trade. Marking up yourtarget and stop levels will allow you to be more alert both to troubleand to profit-taking opportunities. What an on-screen note cannot dois measure your performance. That is something to be accomplished inyour Trader’s Spreadsheet and transferred into your Diary.Question 26—Pinning a Chart to a Wall“Margret’s method”—pinning a chart to a wall and marking the tradingsignal for which you will be waiting—has all of the following advantages, except:1. It forces you to clearly express what price or indicator action youexpect.2. It keeps you from forgetting a plan.3. Removing the charts from the wall if your plans change helps keepyour mind fresh.4. Keeping charts on a wall ensures that you will act when the time isright.Answer: 4
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Printing out a chart and marking up the signals that will prompt youto act is an effective way of monitoring your trading ideas. Seeing thosecharts whenever you approach your desk provides a powerful reminderof your plans. The bulletin board needs to be periodically purged, toprevent it from turning into an archive of old ideas. Still, no system, nomatter how logical, will force you to act—only you can supply themotivation.Question 27—A Trial-Sized OrderWhich of the following statements about a “Chihuahua trade”—a trialsized order designed to draw your attention to a trading opportunity—is correct?1. There is little difference between an electronic alert and an orderfor a handful of shares.2. Chihuahua orders are good for placing stops.3. Getting a fill on a Chihuahua order forces you to make a decision.4. Once you have a fill on a trial-sized order, you must bring that tradeup to full size.Answer: 3There is a huge emotional difference between receiving a fill for areal trade and getting an e-mail reminding you that a certain level hasbeen reached. You are likely to pay attention to the first while dismissing the second as just another claim on your time in the midst ofa busy day. Chihuahua orders are good for entering trades but not forstops—when a stop level is reached, it is time to run. Not everyChihuahua trade must be brought up to full size—in some trades youmay choose to sell the pup instead.Question 28—Grading Buys and SellsFind the incorrect statement about grading buys or sells:1. The closer you buy to the low of the bar, the better your grade.2. The closer you sell to the low of the bar, the better your grade.3. Selling above the midpoint of the bar earns a positive grade.4. Buying in the lowest quarter of the bar earns an excellent grade.
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Answer: 2You want to buy as near the low of the bar and sell as near the highof the bar as possible. Buying in the top quarter or selling in the bottomquarter of the daily bar is a loser’s game; buying below or selling abovemidpoint is very good, while buying in the bottom quarter or sellingin the upper quarter of the daily bar gives you an excellent grade.Question 29—Grading Completed TradesFind the correct statement about grading completed trades:1. Money is a good measure of the quality of each trade.2. A long-term trend trader can use channels to measure the quality oftrades.3. A trade capturing over 30% of a channel earns an “A.”4. A trade capturing less than 20% of a channel earns a “D.”Answer: 3Money, reflected in the equity curve of your account, provides agood measure of your overall trading skill, but it is a poor measure ofany individual trade. Channels provide a good yardstick for swingtrades but a long-term trader needs a different measure, such as thepercentage by which he multiplied his capital. The quality of shortterm swing trades is best measured by comparing gains to the heightof the channel on the daily chart. Capturing at least 30% of that channel earns you an A, 20% a B, 10% a C, while a loss gets a D.Question 30—BuyingFind the incorrect statement about buying:1. The principle of value buying is “buy low, sell high.”2. The principle of momentum buying is “buy high, sell even higher.”3. The upper channel line identifies the level of depression and thelower channel line the level of mania in the markets.4. Momentum trading works well in runaway trends.Answer: 3In quiet markets it makes sense to try to buy at or below value anduse channels to sell above value. Momentum trading, such as buying
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upside breakouts, works better in runaway trends. When prices riseabove the upper channel line, they identify a flash of unsustainableoptimism, a zone of market mania. When they fall below the lowerchannel line, they identify the zone of fear and pessimism.Question 31—ValueBBB
CA
A
A
Figure 1.31
Please match the following descriptions with the letters on the chart:1. Value zone2. Below value—consider buying3. Overvalued—consider sellingAnswers: 1. C2. A3. BIf each price is a snapshot, then a moving average is a compositephotograph, a