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Question 1 of 10
1. Question
Which of the following mistakes did losers tend to do which is/are not advisable for a trader to do?
I. They lose more in their winning positions than they make in their losing positions.
II. They have few fears or reservations before a losing trade but plenty after.
III. They get trapped by other’s doubts, brought about by previous mistakes. They tend to overanalyze (particularly after a string of losers) to the point that they get trapped into inaction. As a result, they miss the best trades while watching from the sidelines.
IV. They take on high-risk trades because they visualize only the profits and not what could go wrong. Then, if something does go wrong, the stress can put them on tilt. Some losers are compulsive, always needing to play, regardless of whether the odds favor their play.
Correct
Here’s what the losers do (train yourself not to do these things):
• They lose more in their losing positions than they make in their winning positions.
• They get aggressive with their losers (by adding to them, or “averaging down”).
• They have few fears or reservations before a losing trade but plenty after.
• They get trapped by their own self-doubts, brought about by previous mistakes. They tend to overanalyze (particularly after a string of losers) to the point that they get trapped into inaction. As a result, they miss the best trades while watching from the sidelines. They price every trade (instead of entering ”at the market”), and because of this, they miss some good ones but are filled with every bad one.
• They have a goal (and that’s fine) but get obsessed about reaching that goal (which is not good). This allows losers to get out of control.
• They take on high-risk trades because they visualize only the profits and not what could go wrong. Then, if something does go wrong, the stress can put them on tilt. Some losers are compulsive, always needing to play, regardless of whether the odds favor their play.
• They’re opinionated, argumentative, and great at placing blame (on the broker, the funds, the government—anything but what they’re in control of).
Incorrect
Here’s what the losers do (train yourself not to do these things):
• They lose more in their losing positions than they make in their winning positions.
• They get aggressive with their losers (by adding to them, or “averaging down”).
• They have few fears or reservations before a losing trade but plenty after.
• They get trapped by their own self-doubts, brought about by previous mistakes. They tend to overanalyze (particularly after a string of losers) to the point that they get trapped into inaction. As a result, they miss the best trades while watching from the sidelines. They price every trade (instead of entering ”at the market”), and because of this, they miss some good ones but are filled with every bad one.
• They have a goal (and that’s fine) but get obsessed about reaching that goal (which is not good). This allows losers to get out of control.
• They take on high-risk trades because they visualize only the profits and not what could go wrong. Then, if something does go wrong, the stress can put them on tilt. Some losers are compulsive, always needing to play, regardless of whether the odds favor their play.
• They’re opinionated, argumentative, and great at placing blame (on the broker, the funds, the government—anything but what they’re in control of).
Question 2 of 10
2. Question
Which of the following things that a trader should do to win?
I. They make more in their losing positions than they win in their losing positions.
II. They trade for the future, guided by what the market is doing (reality) and not their bias of what the market should be doing (hope). And they are totally prepared, ready to take the trades. They have a plan and follow it.
III. They take on a high-risk trade only if there’s an edge in that trade—a favorable risk-to-reward ratio. They have the patience to wait for the best signals, and when signaled, they can act without reservations or anxiety. They have the ability to buy or sell “at the market,” knowing they could miss some of the best trades by pricing.
IV. Because they have a plan and the discipline to follow it, they are relaxed, without stress or excuses. How do I avoid stress during trading hours? I do my market analysis before the market opens and write out a script with the plan of action for varying circumstances.
Correct
Here’s what the winners do (train yourself to do these things):
They make more in their winning positions than they lose in their losing positions. How do they accomplish this? By (a) holding the winners longer and (b) by being bold—getting aggressive with winners by sizing up. They have the ability, on good days, to quickly make back the bad day’s losses.
• They trade in the present, guided by what the market is doing (reality) and not their bias of what the market should be doing (hope). And they are totally prepared, ready to take the trades. They have a plan, and follow it. Once in a trade, if the market is giving them what they expected, they play it out; however, if it isn’t, they accept what the market is prepared to give them. Again, this is reality versus hope.
• They take on a high-risk trade only if there’s an edge in that trade—a favorable risk-to-reward ratio. They have the patience to wait for the best signals, and when signaled, they can act without reservations or anxiety. They have the ability to buy or sell “at the market,” knowing they could miss some of the best trades by pricing. They realize that “bad price fills” can many times be a symptom of the very best trades.
• Because they have a plan and the discipline to follow it, they are relaxed, without stress or excuses. How do I avoid stress during trading hours? I do my market analysis before the market opens and write out a script with the plan of action for varying circumstances. . . While I don’t always trade “at the market” (at times I try to price an entry better using a limit order), if I don’t get the trade on fairly quickly, I will not hesitate to go “at the market” to get it on (even if I have to “pay up”). When the trade is completed, I review what I did right and what I did wrong. Did I get out too soon (profitable trades) or too late (losing trades)? Did I size up correctly to maximize my profit? Did I act in a disciplined, consistent manner, or did I panic or gamble?
Incorrect
Here’s what the winners do (train yourself to do these things):
They make more in their winning positions than they lose in their losing positions. How do they accomplish this? By (a) holding the winners longer and (b) by being bold—getting aggressive with winners by sizing up. They have the ability, on good days, to quickly make back the bad day’s losses.
• They trade in the present, guided by what the market is doing (reality) and not their bias of what the market should be doing (hope). And they are totally prepared, ready to take the trades. They have a plan, and follow it. Once in a trade, if the market is giving them what they expected, they play it out; however, if it isn’t, they accept what the market is prepared to give them. Again, this is reality versus hope.
• They take on a high-risk trade only if there’s an edge in that trade—a favorable risk-to-reward ratio. They have the patience to wait for the best signals, and when signaled, they can act without reservations or anxiety. They have the ability to buy or sell “at the market,” knowing they could miss some of the best trades by pricing. They realize that “bad price fills” can many times be a symptom of the very best trades.
• Because they have a plan and the discipline to follow it, they are relaxed, without stress or excuses. How do I avoid stress during trading hours? I do my market analysis before the market opens and write out a script with the plan of action for varying circumstances. . . While I don’t always trade “at the market” (at times I try to price an entry better using a limit order), if I don’t get the trade on fairly quickly, I will not hesitate to go “at the market” to get it on (even if I have to “pay up”). When the trade is completed, I review what I did right and what I did wrong. Did I get out too soon (profitable trades) or too late (losing trades)? Did I size up correctly to maximize my profit? Did I act in a disciplined, consistent manner, or did I panic or gamble?
Question 3 of 10
3. Question
Which of the following statements is/are true for margin deposits?
I. Margin deposits are set by the director, and they can change with price movements and market volatility.
II. Because you are trading for future delivery and borrowing everything, interest is charged on the balance.
III. Margin is money deposited in your brokerage account that serves to guarantee the performance of your side of the contract.
IV. If you make money on the trade, upon liquidation, your total margin deposit is returned, along with your profits. Commissions are
deducted, and they are a cost.
Correct
Margin deposits are set by the Exchange, and they can change with price movements and market volatility. Because you are trading for future delivery and not borrowing anything, no interest is charged on the balance. Margin is not a partial payment or a down payment at all, and it’s not even considered a cost. If you make money on the trade, upon liquidation, your total margin deposit is returned, along with your profits. Commissions are deducted, and they are a cost. Margin is money deposited in your brokerage account that serves to guarantee the performance of your side of the contract. Margin is a form of “earnest money” deposited by both the longs and the shorts, and it serves to ensure the integrity of every futures transaction. In effect, margin ensures that you are paid when you win and that whoever is on the other side of your transaction is paid if you don’t.
Incorrect
Margin deposits are set by the Exchange, and they can change with price movements and market volatility. Because you are trading for future delivery and not borrowing anything, no interest is charged on the balance. Margin is not a partial payment or a down payment at all, and it’s not even considered a cost. If you make money on the trade, upon liquidation, your total margin deposit is returned, along with your profits. Commissions are deducted, and they are a cost. Margin is money deposited in your brokerage account that serves to guarantee the performance of your side of the contract. Margin is a form of “earnest money” deposited by both the longs and the shorts, and it serves to ensure the integrity of every futures transaction. In effect, margin ensures that you are paid when you win and that whoever is on the other side of your transaction is paid if you don’t.
Question 4 of 10
4. Question
If the initial margin requirement is $3000, then how much should be the maintenance margin?
Correct
Assume that corn is trading at $6 per bushel, and the initial margin requirement is $2,000. A corn contract has a size of 5,000 bushels, so at $6 per bushel, the total value of the contract is $30,000. However, all that is required to purchase or sell a contract is $2,000 (in his example, about 6%). A rule of thumb for maintenance margin is that it will be at the 75% level of initial. If the initial is $2,000, for example, maintenance might be $1,500.
Incorrect
Assume that corn is trading at $6 per bushel, and the initial margin requirement is $2,000. A corn contract has a size of 5,000 bushels, so at $6 per bushel, the total value of the contract is $30,000. However, all that is required to purchase or sell a contract is $2,000 (in his example, about 6%). A rule of thumb for maintenance margin is that it will be at the 75% level of initial. If the initial is $2,000, for example, maintenance might be $1,500.
Question 5 of 10
5. Question
Why it is recommended to trade in the active month?
I. The active month is the one with the lowest open interest.
II. Active months have the greatest number of players and, therefore, the most liquidity.
III. Because of greater liquidity, you can get in and out with a large degree of slippage.
IV. Slippage means having your order filled at a price unfavorably different from that which existed as the last trade.
Correct
Which month should you trade? This is a general rule of thumb only, but unless you have a specific reason for trading a specific month, trade the active month. For example, say that it’s May but you want to be short December corn because this is the first new crop month and, despite tight supplies, you think there’s a big crop coming and predict that this month will fall faster. Otherwise, you would trade the active month. The active month is the one with the highest open interest, and you can obtain this information from the Exchange for any particular commodity at any point in time. This is because the active months have the greatest number of players and, therefore, the most liquidity. Because of this, you can get in and out with a smaller degree of slippage. Slippage, in effect, means having your order filled at a price unfavorably different from that which existed as the last trade.
Incorrect
Which month should you trade? This is a general rule of thumb only, but unless you have a specific reason for trading a specific month, trade the active month. For example, say that it’s May but you want to be short December corn because this is the first new crop month and, despite tight supplies, you think there’s a big crop coming and predict that this month will fall faster. Otherwise, you would trade the active month. The active month is the one with the highest open interest, and you can obtain this information from the Exchange for any particular commodity at any point in time. This is because the active months have the greatest number of players and, therefore, the most liquidity. Because of this, you can get in and out with a smaller degree of slippage. Slippage, in effect, means having your order filled at a price unfavorably different from that which existed as the last trade.
Question 6 of 10
6. Question
Which of the following statements is/are true regarding price in the options contract?
I. If the price of the commodity is too high in relation to the futures price, then the people involved in the use of a particular commodity sell the low-priced futures contracts and take delivery. Their buying, in effect, pushes futures prices up to meet the physical price.
II. If the price of a futures contract is too high in relation to the actual commodity, then producers of that commodity sell the contract to make a delivery because the higher-priced futures (in relation to the physical) just might be their best sale. Their selling pushes the price of the futures down to the cash price.
III. If the price of the commodity is too high in relation to the futures price, then the people involved in the use of a particular commodity buy the low-priced futures contracts and take delivery. Their buying, in effect, pushes futures prices up to meet the physical price.
IV. If the price of a futures contract is too high in relation to the actual commodity, then producers of that commodity buy the contract to make a delivery because the higher-priced futures (in relation to the physical) just might be their best sale. Their selling pushes the price of the futures down to the cash price.
Correct
This option is as important in theory as in practice because it is what allows physical commodity prices and the Exchange-traded contracts to come together at price. If the price of the commodity is too high in relation to the futures price, then the people involved in the use of a particular commodity buy the low-priced futures contracts and take delivery. Their buying, in effect, pushes futures prices up to meet the physical price. If the price of a futures contract is too high in relation to the actual commodity, then producers of that commodity sell the contract to make a delivery because the higher-priced futures (in relation to the physical) just might be their best sale. Their selling pushes the price of the futures down to the cash price. This entire process is known as convergence. This potential process of convergence is what makes the system work; however, in practice, only 1% to 2% of all commodity contracts end in delivery. Odds are that you, as a speculator, will never get involved in delivery, and there’s no need to. In fact, even the majority of hedgers do not use the markets to actually make or take delivery; they use the futures as a pricing tool to help stabilize their revenues and their costs.
Incorrect
This option is as important in theory as in practice because it is what allows physical commodity prices and the Exchange-traded contracts to come together at price. If the price of the commodity is too high in relation to the futures price, then the people involved in the use of a particular commodity buy the low-priced futures contracts and take delivery. Their buying, in effect, pushes futures prices up to meet the physical price. If the price of a futures contract is too high in relation to the actual commodity, then producers of that commodity sell the contract to make a delivery because the higher-priced futures (in relation to the physical) just might be their best sale. Their selling pushes the price of the futures down to the cash price. This entire process is known as convergence. This potential process of convergence is what makes the system work; however, in practice, only 1% to 2% of all commodity contracts end in delivery. Odds are that you, as a speculator, will never get involved in delivery, and there’s no need to. In fact, even the majority of hedgers do not use the markets to actually make or take delivery; they use the futures as a pricing tool to help stabilize their revenues and their costs.
Question 7 of 10
7. Question
Which of the following statements is/are true regarding the basis in short and long hedge?
I. If a short hedger (one who sells futures) experiences a widening of the basis (where cash prices have fallen to a greater degree than futures—either cash has fallen faster or risen slower than futures), a basis loss may result. In other words, the short hedger’s cash position loss may be greater than the gain realized on the futures side of the transaction.
II. In a rising market, the gain on the cash side of the transaction would be as large as the loss on the futures side.
III. A basis gain would occur with a widening basis on a short hedge. The futures would rise in price to a greater degree than the cash.
IV. A narrowing basis yields additional gains for a short hedger (the cash falls less, or rises more, in relation to the futures) and incremental losses for a long hedger (the cash falls less, or rises more, in relation to the futures).
Correct
The basis
In these examples, I have kept the basis fairly constant, but in reality, it can change. If a short hedger (one who sells futures) experiences a widening of the basis (where cash prices have fallen to a greater degree than futures—either cash has fallen faster or risen slower than futures), a basis loss may result. In other words, the short hedger’s cash position loss may be greater than the gain realized
on the futures side of the transaction. Or, in a rising market, the gain on the cash side of the transaction would not be as large as the loss on the futures side. Conversely, a basis gain would occur with a widening basis on a long hedge. The futures would rise in price to a greater degree than the cash. A narrowing basis yields additional gains for a short hedger (the cash falls less, or rises more, in relation to the futures) and incremental losses for a long hedger (the cash falls less, or rises more, in relation to the futures). Basis gains or losses are a risk to a hedger, but they’re not nearly as big a risk as what is called flat price risk. The price of heating oil may move 20¢ per gallon in a couple of days, whereas the basis might move 1¢ either way. For example, the flat price move could be a result of a warmer-than-normal, winter whereas the basis change may be due to the fact it was colder in New Haven than New York that particular winter. A speculator might analyze basis changes to help determine the strength or weakness of a market, but this is really more of a hedger’s concern.
Incorrect
The basis
In these examples, I have kept the basis fairly constant, but in reality, it can change. If a short hedger (one who sells futures) experiences a widening of the basis (where cash prices have fallen to a greater degree than futures—either cash has fallen faster or risen slower than futures), a basis loss may result. In other words, the short hedger’s cash position loss may be greater than the gain realized
on the futures side of the transaction. Or, in a rising market, the gain on the cash side of the transaction would not be as large as the loss on the futures side. Conversely, a basis gain would occur with a widening basis on a long hedge. The futures would rise in price to a greater degree than the cash. A narrowing basis yields additional gains for a short hedger (the cash falls less, or rises more, in relation to the futures) and incremental losses for a long hedger (the cash falls less, or rises more, in relation to the futures). Basis gains or losses are a risk to a hedger, but they’re not nearly as big a risk as what is called flat price risk. The price of heating oil may move 20¢ per gallon in a couple of days, whereas the basis might move 1¢ either way. For example, the flat price move could be a result of a warmer-than-normal, winter whereas the basis change may be due to the fact it was colder in New Haven than New York that particular winter. A speculator might analyze basis changes to help determine the strength or weakness of a market, but this is really more of a hedger’s concern.
Question 8 of 10
8. Question
Which of the following statements is/are not true for speculators?
I. A speculator tries to make money by buying low and selling high (or vice versa).
II. A speculator is a marketplace participant who is neither a producer nor a consumer of a commodity or financial instrument.
III. A speculator is in need of the underlying commodity.
IV. Without speculators, the system would not work as they add liquidity. Speculators often take the other side of the bids and offer in the marketplace put out by consumers.
Correct
Speculators versus hedgers
It doesn’t matter whether the user needs copper or soybean oil or to purchase yen six months hence; any market in which prices fluctuate creates price risk for commercial participants, which in turn creates the need for a hedging tool. Remember, hedgers are not trying to make a killing in the market; they wish to offset price risks. A speculator, on the other hand, tries to make money by buying low and selling high (or vice versa). A speculator is a marketplace participant who is neither a producer nor a consumer of a commodity or financial instrument. By definition, he does not have or wants the underlying commodity, and this participant could be you or me. Without speculators, the system would not work; they add liquidity. Speculators often take the other side of the bids and offer in the marketplace put out by hedgers. At times, they take the other side of a speculative bid and offer, and at times, different hedgers may be on both sides of a transaction. However, a trade cannot be completed unless someone is willing to take the other side, and if there were only hedgers and no
speculators, the system would not operate smoothly. By assuming the risks the hedgers are trying to avoid, the speculators will make money when they are right and lose when wrong.
Incorrect
Speculators versus hedgers
It doesn’t matter whether the user needs copper or soybean oil or to purchase yen six months hence; any market in which prices fluctuate creates price risk for commercial participants, which in turn creates the need for a hedging tool. Remember, hedgers are not trying to make a killing in the market; they wish to offset price risks. A speculator, on the other hand, tries to make money by buying low and selling high (or vice versa). A speculator is a marketplace participant who is neither a producer nor a consumer of a commodity or financial instrument. By definition, he does not have or wants the underlying commodity, and this participant could be you or me. Without speculators, the system would not work; they add liquidity. Speculators often take the other side of the bids and offer in the marketplace put out by hedgers. At times, they take the other side of a speculative bid and offer, and at times, different hedgers may be on both sides of a transaction. However, a trade cannot be completed unless someone is willing to take the other side, and if there were only hedgers and no
speculators, the system would not operate smoothly. By assuming the risks the hedgers are trying to avoid, the speculators will make money when they are right and lose when wrong.
Question 9 of 10
9. Question
Which of the following is/are true for limit orders?
I. A limit order prevents from paying less than the limit price on a buy order or receive more than the limit price on a sell order.
II. The drawback of a limit order is that there is no guarantee that we will get in.
III. If the market doesn’t reach the limit, we can revert to a market order.
IV. A limit order is an order to buy or sell at the prevailing price.
Correct
Limit order
When you place a limit order, you know what you will get in the worst-case scenario (you could get better), but there are strings attached. A limit order prevents you from paying more than the limit price on a buy order or receive less than the limit price on a sell order. However, unless the market is willing to meet your terms, you will not get in. The drawback of a limit order is that there is no guarantee you will get in. You could miss trades. You are not even assured that you will get in if your limit price is hit. In the preceding example, if you place a limit order to buy at “50 or better” and the market touches 50, this may be your trade, or it may be someone else’s. You can be only reasonably assured that you are in if the market trades lower than 50. It is frustrating to place an order to buy at 50, see the market trade there once and find that you’re not filled just as the market’s crossing 75. That’s not to say there isn’t a place for limit orders. I like to use them in quiet, back-and-forth-type markets so as not to give up the slippage seen with a market order. I also use them to take profits in a good position. I try to let the market reach out to my limit price. After all, if the market doesn’t reach my limit, I can always revert to a market order.
Incorrect
Limit order
When you place a limit order, you know what you will get in the worst-case scenario (you could get better), but there are strings attached. A limit order prevents you from paying more than the limit price on a buy order or receive less than the limit price on a sell order. However, unless the market is willing to meet your terms, you will not get in. The drawback of a limit order is that there is no guarantee you will get in. You could miss trades. You are not even assured that you will get in if your limit price is hit. In the preceding example, if you place a limit order to buy at “50 or better” and the market touches 50, this may be your trade, or it may be someone else’s. You can be only reasonably assured that you are in if the market trades lower than 50. It is frustrating to place an order to buy at 50, see the market trade there once and find that you’re not filled just as the market’s crossing 75. That’s not to say there isn’t a place for limit orders. I like to use them in quiet, back-and-forth-type markets so as not to give up the slippage seen with a market order. I also use them to take profits in a good position. I try to let the market reach out to my limit price. After all, if the market doesn’t reach my limit, I can always revert to a market order.
Question 10 of 10
10. Question
How can the following orders of the stop orders be useful to enter a new position in the market?
I. A buy stop is used to initiate a new position under the market on momentum.
II. A sell stop is used above the market.
III. With a stop-limit order, if the stop price is touched, a trade must be executed at the market price (or better) or held until the stated price is reached again.
IV. If the market fails to return to the stop limit level, the order is not executed.
Correct
However, when used correctly, these can be useful orders to enter a new position. While a buy stop would be used to initiate a new position above the market on momentum (if not in the market), a sell stop would be used under the market. There additionally is a variation of a stop order called a stop limit. With a stop-limit order, if the stop price is touched, a trade must be executed at the limit price (or better) or held until the stated price is reached again. The risk with the stop limit is the same as with a straight limit. In other words, if the market fails to return to the stop limit level, the order is not executed, so I normally do not recommend its use. It can, in a fast-moving market, defeat the purpose of the stop (to stop your loss).
Incorrect
However, when used correctly, these can be useful orders to enter a new position. While a buy stop would be used to initiate a new position above the market on momentum (if not in the market), a sell stop would be used under the market. There additionally is a variation of a stop order called a stop limit. With a stop-limit order, if the stop price is touched, a trade must be executed at the limit price (or better) or held until the stated price is reached again. The risk with the stop limit is the same as with a straight limit. In other words, if the market fails to return to the stop limit level, the order is not executed, so I normally do not recommend its use. It can, in a fast-moving market, defeat the purpose of the stop (to stop your loss).
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