CMT Level III flashcards
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33 cards. Read the term and the definition here. The deck at the top of this page is optional.
- Higher high, higher low
- Structural definition of an uptrend. Each successive rally peak exceeds the prior peak and each pullback trough stays above the prior trough. Breaking the latest higher low is the first reversal warning.
- Dow Theory confirmation
- A primary trend signal requires both the industrial and transport averages to confirm each other. One average making a new extreme alone is treated as unconfirmed and unreliable.
- Secondary reaction
- In Dow Theory, a counter-trend move lasting weeks to months that retraces roughly one-third to two-thirds of the prior primary advance, after which the primary trend resumes.
- RSI formula
- RSI = 100 − 100/(1 + RS), where RS is average gain divided by average loss over N periods using Wilder smoothing. Values run from 0 to 100.
- RSI overbought reading
- An RSI above 70 indicates momentum is stretched relative to recent history. In strong uptrends it can persist for long stretches, so it is not a standalone sell signal.
- MACD histogram
- The MACD line minus its nine-period signal line. Rising bars show accelerating momentum; shrinking bars show momentum fading even while price still advances.
- Bollinger Band squeeze
- A contraction of band width to unusually low levels, reflecting compressed volatility. It signals that a larger directional move is likely, not which direction it will take.
- Moving average whipsaw
- Repeated false crossover signals in a range-bound market. Shorter lookback lengths and closely spaced fast/slow pairs increase the frequency of these unprofitable signals.
- Volume confirmation rule
- A price breakout accompanied by volume above its recent average has a higher success rate. Breakouts on below-average volume carry elevated failure risk and often retrace.
- Oscillator divergence
- Price makes a new high while the oscillator makes a lower high (bearish), or price makes a new low while the oscillator makes a higher low (bullish). Signals fading momentum, not immediate reversal.
- Pattern measured target
- The projected objective for a chart formation, computed as the height of the pattern added to (or subtracted from) the breakout price. Used for reward-to-risk sizing.
- Support becomes resistance
- Once a support level is decisively broken, it commonly acts as resistance on the subsequent rally, because trapped buyers sell to exit near their entry price.
- Relative strength line
- A ratio of the security's price to a benchmark index, plotted over time. A rising line means the security is outperforming the benchmark regardless of absolute price direction.
- Average true range
- The average of the greatest of: current high minus low, high minus prior close, and prior close minus low. Measures volatility in price units for stop placement.
- Trendline validity
- A trendline gains validity with the number of independent touches and the time span covered. A third touch is the conventional minimum for treating it as meaningful.
- Overbought in a downtrend
- An oscillator reaching an overbought level within a larger downtrend frequently marks a shorting opportunity rather than a reversal, because the primary trend remains down.
- Sample standard deviation
- σ = sqrt( Σ (r_i − r̄)² / (n − 1) ). Dividing by n − 1 rather than n corrects the downward bias of variance estimated from a finite sample of returns.
- Annualizing daily volatility
- Multiply the daily standard deviation by the square root of 252, the usual count of trading days. Volatility scales with the square root of time, not linearly.
- Sharpe ratio
- (Portfolio return − risk-free rate) divided by portfolio standard deviation. It measures excess return per unit of total risk and penalizes upside volatility equally with downside.
- Sortino ratio
- (Portfolio return − target return) divided by downside deviation, which counts only returns below the target. It avoids penalizing large gains the way the Sharpe ratio does.
- Beta interpretation
- Covariance of portfolio and benchmark returns divided by benchmark variance. A beta of 1.2 implies the portfolio has historically moved 20 percent more than the benchmark in the same direction.
- R-squared in regression
- The proportion of a portfolio's return variance explained by the benchmark. Low R-squared means beta is a weak descriptor and the portfolio carries large idiosyncratic risk.
- Maximum drawdown
- The largest peak-to-trough decline in portfolio value, expressed as a percentage of the prior peak. Report it alongside the time required to recover the lost value.
- Value at Risk
- The loss threshold not expected to be exceeded with a stated probability over a stated horizon. It is silent about how severe losses are beyond that threshold.
- Expected shortfall
- The average loss conditional on losses exceeding the Value at Risk threshold. Also called conditional VaR; it is a coherent risk measure that captures tail severity.
- Two-asset portfolio variance
- w₁²σ₁² + w₂²σ₂² + 2w₁w₂ρσ₁σ₂. The covariance term falls as correlation drops, which is the mathematical source of diversification benefit.
- Position size formula
- Shares = (equity × risk fraction) / (entry price − stop price). It converts a per-trade risk budget into a share count based on the stop distance.
- Risk of ruin
- The probability of losing enough capital to stop trading. It increases with per-trade risk fraction and trade frequency, even when the system has positive expectancy.
- Tracking error
- The standard deviation of the difference between portfolio and benchmark returns. It quantifies active risk and is undefined without a specified benchmark.
- Information ratio
- Active return divided by tracking error. It measures how much benchmark-relative excess return is generated per unit of active risk taken.
- Correlation of one
- When two assets move perfectly together, portfolio variance equals the weighted sum of their volatilities. No diversification benefit exists at this correlation level.
- Downside deviation
- The square root of the average squared shortfall below a target return, counting only periods that fall short. It is the denominator of the Sortino ratio.
- Calmar ratio
- Annualized return divided by maximum drawdown. It relates reward to the worst peak-to-trough loss, making it sensitive to a single historical drawdown episode.