Technical Analysis of Financial Markets: Integrating Evidence into a Testable Market View
Domain scope
CMT Level II tests synthesis, not definition recall. Candidates must combine trend, momentum, volume, breadth, sentiment, cycles, and intermarket evidence into a coherent, testable market view. Questions often ask which tool answers a specific question, whether a signal is confirmed across timeframes, and whether an apparent edge survives realistic costs and out-of-sample testing.
Core rules
- Price is primary; indicators are transformations of price, volume, or related data. Use an indicator only when it adds information about persistence, exhaustion, or participation.
- Define trend by market structure: successive higher highs and higher lows in an uptrend, lower highs and lower lows in a downtrend. A moving-average slope is secondary; a break of structure usually outweighs a moving-average crossover.
- Seek independent confirmation. Volume supports breakouts; breadth tests participation; credit, commodity, and currency markets can reveal macro transmission. Two correlated momentum measures are not independent confirmation.
- Distinguish absolute from relative strength. A stock can rise while underperforming its sector; relative strength compares price with a benchmark over a defined window.
- Treat sentiment extremes as conditions, not timing signals. A crowded position needs price rejection or failed follow-through before it becomes actionable.
- For systems, specify universe, signal, position sizing, costs, slippage, and out-of-sample validation. Prefer rules with an economic or behavioral rationale over mined patterns.
Worked example
A stock breaks above a six-month range at 50 on volume 1.4 times its 20-day average. Breadth in its sector improves, but relative strength versus the sector falls and RSI is 72. Reasoning: volume and breadth confirm participation, so the breakout is credible; falling relative strength warns that leadership is weakening, and RSI 72 alone is not a sell signal. The trade can be taken with reduced size, a stop below the breakout level, and an invalidation rule: a close back inside the range or further deterioration in relative strength. The candidate should explain that overbought momentum reflects strength, while relative-strength divergence reflects opportunity cost.
Traps that cost marks
Treating overbought or oversold readings as automatic reversals; counting correlated indicators as multiple confirmations; using sentiment without a price trigger; ignoring timeframe consistency; confusing absolute price gains with relative strength; and presenting backtests without costs, survivorship controls, or out-of-sample evidence.