CMT Level III Sample Exam Guide

CMT Sample Exam Level III
CMT LEVEL III SAMPLE EXAM
This is a sample exam. Questions here are intended to be indicative of the
style you will encounter when taking the Level III examination. These are NOT a
comprehensive review of all the items in the curriculum that may be tested. Not all
topics in the book will appear during any given exam administration. This sample
exam attempts to demonstrate possible scenarios.
Any direct resemblance to actual future test questions is neither
implied nor intended.
The table below gives a description of the expected composition of each
CMT Level III exam. In addition to this information, candidates should be aware
that the point count for each exam question can also be used as an indication of
how much time to spend answering a question.
The guidance is that one point will equal one minute of time spent. For
example, a question worth 15 points would be intended to be difficult enough that
a candidate would use 15 minutes of time. Candidates should try to not use much
more than this amount so that they will have enough time to complete other
questions. The point value will vary from one question to the next, so this is
merely a guideline to follow for time management purposes during the exam.
Sections
in Exam
Number of
Questions
Topics Covered Points
in each
Section
8 total
Plan to
spend 20 to
40 minutes
per section
3 to 8
per section
Use the
points as a
guideline for
intended
time
allocation
Each of the exam questions will consist of an integrated
mix of two or three knowledge domains from among
those specified on the mta.org website:
Risk Management, Asset Relationships, Portfolio
Management, Classical Methods, Behavioral Finance,
Volatility Analysis.
12 for Ethics
20 to 40 points
for other
sections.
These will vary
for each exam.

SECTION #1: ETHICS (12 POINTS)
1. Jorge Salvador, CMT, is a technical analyst for a buy-side firm. He
works researching developing countries with rapidly modernizing
economies. Securities laws in these countries are not as extensive as
elsewhere.
When Salvador is approached by a corporate owner within one of these
countries, which of the following is correct? (2 points)
A) Salvador does not to worry about violating rules and laws
governing insider information.
B) Salvador must write a report of all his communications and
inform management periodically.
C) Salvador does not need to be concerned about U.S. rules since he
is researching a developing country.
D) Salvador may be required to abide by the requirements of the
Code and Standards even if there is a distinction between
rules of the code and developing country.

2. Bobby Guyer, CMT, manages several discretionary accounts for clients
as a Registered Investment Advisor. Bobby has begun to use twitter
messages to communicate new ideas he is looking at as possible
short-term trades in his client portfolios. His clients love getting the
information because they feel he is keeping them up to the minute.
The problem is that about half of his client accounts are not suitable
for such trades. Bobby has not communicated with these clients
about the difference in the trades he sends out on twitter. Some of
the clients he has have begun to ask for more information about how
they can participate in such trades, which is Bobby’s intent.
Which of the following is most accurate regarding Bobby’s de facto
marketing behavior? (2 points)
A) Bobby is in violation of Standard III(C.2) because his
recommendations are not consistent with the original mandate
given him for half of his clients.
B) Bobby is not in violation Standard III(C) because he does not
force any trades on his clients.
C) Bobby is not in violation Standard III(C.2) because his
communications comply with the existing guidance and
regulation governing use of social media.
D) Bobby is in violation of Standard III(C) because he manages
discretionary accounts.

3. Scott Fielding, CMT, is a strategist for a firm that manages high-net-
worth portfolios at a large global bank. The Director of sales has
asked him for some figures to help launch a new specialized fund
offering based on one of his strategies. The Director is looking for a
5-year track record. Scott only has one year of out-of-sample data
trading the system; the other four years are a back test. The Director
persuades him that the firm should publish all five years of data.
Which of the following statements is most likely correct? (2 points)
A) Fielding and the Director have solid data on the strategy so they
are not misrepresenting the performance over the past five
years.
B) Fielding and the Director have violated Standard II(A) by sharing
material nonpublic information.
C) Fielding and the Director have violated Standard I(C) by
misrepresenting their data as actual performance data instead
of theoretical modeling and backtesting.
D) Fielding and the Director have violated Standard III by not
dealing fairly with the clients.

4. Shelly Ulsterlow, CMT, is a senior technical analyst for an investment
banking firm. She is frequently asked to make media appearances on
market conditions. In the course of a recent appearance, her
interviewer asked her about a sizable position her bank was rumored
to have purchased in a pre-IPO company. Although Ulsterlow didn’t
know anything about this situation, she did not want to appear
uninformed about her own company so she acknowledged the rumor
and began to articulate information she assumed would be correct.
Which of the following statements is most accurate? (2 points)
A) Ulsterlow is protected by the First Amendment of the U.S.
constitution and can say whatever she wants as part of
journalistic license.
B) Ulsterlow is not in violation of any of the CFA Standards of
Professional Conduct.
C) Ulsterlow is in violation of multiple standards listed in the CFA
Standards of Professional Conduct.
D) Ulsterlow is in violation of only Standard II(B) because her
statements may manipulate the perceived market value of the
pre-IPO company.

5. Ren Griswold, CMT, manages a portfolio of managed futures accounts
for several institutional clients. He invests in various spread
strategies involving a number of commodities. Griswold has a hunch
that Gold prices are about to soar higher. In the past his hunches
have been highly profitable investments, so he asks his technical
analyst to draft up a bullish outlook for gold that he can use to help
persuade his clients to allocate more money toward gold than his
mandate normally allows. Which of the following statements about
Griswold is the most accurate? (2 points)
A) Griswold should do the analysis himself so that is not likely to be
in violation of Standard III(A) by not acting with prudence
and care.
B) Griswold should do the analysis himself because the data is likely
to be misrepresented otherwise.
C) Griswold’s associate is not likely to be objective with his report
and sharing that information would be in violation of
Standard I(B).
D) Griswold’s associate is not likely to be objective with his report
and sharing that information would be in violation of
Standard II(D).

6. James Bunson, CMT, is a proprietary trader who has been trading a
system he has developed and refined over the past five years. His
firm intends to soon use the system in an automated fashion as part
of their CTA business. Bunson finds one day that his performance
data has inadvertently been overstated for the past year by about a
third. Because the firm is only two weeks away from launching their
offering, Bunson decides to say nothing. Which of the following
statements is most likely to be accurate? (2 points)
A) Bunson is not yet in violation of any standards.
B) Bunson is in violation of Standard III(D) by not ensuring that the
data is accurate.
C) Bunson’s system still makes money even if the performance is
slightly overstated, so it really doesn’t matter that he may be
off the mark just a little.
D) Bunson is in violation of Standard IV(A) by being disloyal to his
employer.

SECTION #2: BEHAVIORAL FINANCE (20 POINTS)
7. Identify which five of the following are phases of an asset bubble as
Montier describes them (5 points, 2 point each),
A) Lethargy—markets going nowhere
B) Displacement—exogenous shock triggers profit opportunity in
some sectors but not in others
C) Credit creation—boom and monetary expansion
D) Debt consolidation—consumer confidence dissipates
E) Euphoria—overestimate of returns
F) Critical stage—financial distress as insiders cash out and firms
consider defaulting
G) Revulsion—investors stop participating, paralyzed by fear
H) Capitalization—traders take advantage of market moves
I) Recovery—markets begin to rebound
J) Transition—capital markets become more liquid
8. Investment committees are standard in the investment world and in some
cases are legislated. Groupthink can be a big problem when it comes
to investing. We often see conflicting opinions from the same firm
on market direction.
State two conditions where group decisions are statistically useful. (6
points)
State three potential strategies to reduce group biases. (9 points)

SECTION #3: ASSET RELATIONSHIPS (31 POINTS)
You are a large-cap portfolio manager. Despite your large-cap mandate,
you like to monitor the relative strength ratio of the small-cap stock
index divided by the large-cap stock. After a nine-month downtrend
this relative strength ratio has put in a bottom and has started to
move higher.
9. What sector should you consider adding exposure to? (3 points)
A) Staples
B) Tech
C) Telecom
D) Utilities
10. Give two reasons why small-cap relative strength suggests you should
add to this sector? (6 points)
11. Copper has been selling off for the past month on an absolute basis and
relative to other currencies. As an emerging markets equity manager,
which country should you consider reducing exposure in? (3 points)
A) China
B) India
C) Mexico
D) Russia
12. Explain one reason why weakness in copper would cause you to
consider reducing exposure to this country? (3 points)

Wayne Garthrow, CMT, is a Junior Portfolio Manager for a $3B large-cap equity fund at Illinois
Investment Services Inc. Wayne is part of a team that also consists of a Portfolio Assistant, 2
Client Portfolio Managers and a Senior Portfolio Manager. Wayne was recently added to the
team because of his experience in fusing technical market analysis with economic indicators.
One of the Conference Board’s economic indicators that Wayne finds especially useful is the 4-
Week Moving Average of Initial Jobless Claims. Recently, Wayne noticed that this indicator has
broken higher out of a multi-month base.
Chart 3-1

Chart 3-2
Chart 3-3

13. Compare Chart 3-1 with Chart 3-2 and Chart 3-3. Which of the RRG
chart options is more likely to be an actual snapshot of S&P sector
rotation taking place around the timeframe marked by the letter X on
Chart 3-1 above? (5 points)
A. Chart 3-2
B. Chart 3-3
C. Neither
D. Both
14. Briefly explain the reasons for your choice. Be sure to focus your
comments on sector rotation and the possible implications for the
economy, describe the logic behind your answer. (6 points)
15. Which one of the following lists contains a mix of leading and
lagging indicators? (5 points)
A. ISM New Orders Index, Consumer Sentiment, Interest Rate Spread
B. Building Permits (New Private Housing), Displaced Moving Average,
Manufacturers New Orders
C. Commitment of Traders Report, Odd-Lot Sales, MACD
D. Short Interest Ratio, Forecast EPS growth, Return on Assets

SECTION #4: SYSTEM DEVELOPMENT (35 POINTS)
16. Risk control can involve complex mathematics, but there are a number
of commonsense principles the investment professional can follow
to reduce the risk of ruin. List 3 of the most important commonsense
risk-control rules. (12 points)
17. You work for a CTA firm and have worked hard to develop several
viable trading systems covering a diversified variety of market
instruments. You have taken care to properly test these systems,
avoiding data snooping, or curve-fitting them to in-sample data.
Next, you merged these several systems into an overall portfolio
model. What method might you use to test your hypothesis and
determine the probability of your trading system succeeding? (4
points)
Briefly describe that testing method and its meaning. (6 points)
18. List three steps that, when added to a trading plan, would limit the
major disadvantage of a simple trend-following system. (6 points
total, 2 per answer)

NOTE TO CANDIDATES: QUESTION 16 IS A NEW QUESTION TYPE TO BE USED
BEGINNING OCTOBER 2017.
The following sample question represents a new type of question you will
encounter during the October 2017 exam. This question includes the use of
an interactive spreadsheet table built in to the examination platform. The
purpose of the question is to test a candidate in the way an analyst on the job
may need to perform. For this question a candidate will be expected to edit
the cells of the spreadsheet to determine proper references or calculation of
formulae. This is a way of testing the candidate’s ability to recognize
accurate information and to determine its significance. The actual exam
question will include a similar testing methodology to the one described as
follows.
19. In reviewing a performance analysis of your firm’s two trading
systems, your colleague believes that there is an error in one or more
of the ratio formulas in the spreadsheet below. Your colleague points
out that the entry called “composite score” shows System 1 has a
much higher number than System 2—which seems incorrect to him.
The composite score is an average of the Sharpe Ratio, Treynor
Ratio, and Calmar Ratio, so if a value among the composite scores is
wrong, there may be something wrong with one or more ratio
formulas.
To answer this question you will need to activate the spreadsheet and
identify the error(s) in the formulas, if any, and fix them to
determine the proper Composite scores.
Note: the actual exam will provide instructions on how to activate the
spreadsheet functions in the table.”
Review the following table of information to determine if the calculations
for the performance ratios contain any errors.

System 1 System 2
Starting Equity Value 10,000,000.00
$ 10,000,000.00
$
Trailing 3-year ROR 12.5% 13.5%
Peak Equity Value 16,258,300.00 17,855,600.00
Maximum Drawdown 25% 32%
Std. Dev. Annual 15.5% 22.6%
Largest Loss 8.5% 10.7%
Benchmark Perf. 8.50% 8.5%
Benchmark Std. Dev. 10.50% 10.5%
Risk Free rate 0.25% 0.25%
Sharpe Ratio 0.79 0.59
Treynor Ratio 0.18 0.29
Calmar Ratio 0.50 0.42
Composite score 0.49 0.43
When you activate this spreadsheet table, you’ll see something similar to this:
This allows you to edit the spreadsheet/table in the question. If you click on the
cell for the Sharpe Ratio for System 1, you can see the formula construction and
which cells the formula is referring to. This gives you the ability to check for
errors. Activating the spreadsheet and working within it are a part of answering
the exam question.

(19 continued) Once you have fixed any errors you have found, select
which of the following pairs of composite score reflects the correct
values. (11 points)
Answer System 1 System 2
A .79 .59
B .41 .49
C .39 .41
D .28 .59
(See answer key for this question since you cannot replicate the
answer on a paper test. This explanation and sample question
id not intended for practice examination, but only for
informational purposes.)

SECTION #5: CLASSICAL METHODS (40 POINTS)
Chart 5-1
20. You are newly hired on to XRHO Capital Management, a CTA firm.
Last year the firm took a long position in Coffee futures (KC). The
position is profitable and has met its objectives, and you are tasked
with recommending whether the current conditions suggest it would
be most favorable to sell now or to wait. Select either decision but
explain at least four points of evidence to correctly support your
decision from among the applicable signals on Chart 5-1. (16 points,
4 for each of the four points of evidence)
Answer (either sell now or hold):

Chart 5-2
21. Your predecessor recommended the firm initiate a short position on
MMM, but failed to leave any explanation for this chart. Describe
the three signals the analyst likely observed using available detail on
Chart 5-2. (12 points)
22. Your predecessor recommended the firm enter the short position at
$125 and set a stop-loss at $130. If the firm had a fund of 5 million
dollars and wanted to take the trade and put only 1.5% of that
amount at risk, how many shares could be traded (assuming no loss
to gaps or slippage)? (12 points)

QUESTION #6: CLASSICAL METHODS (20 POINTS)
Examine Chart 6-1 (10-Year U.S. Treasury Prices).
Chart 6-1
23. Identify which circle contains the candle (1, 2, 3, or 4) that was most
significant in forecasting a break above the resistance line. (4 points)
24. Explain two reasons for your selection in question 21. (6 points)
25. What is your short-term forecast for U.S. Treasury bond prices based on
this chart? (10 points)

QUESTION #7: CLASSICAL METHODS (40 POINTS)
Chart 7-1
You are a recently hired analyst. Your portfolio manager wants your short-
term recommendation on GDX, a gold-mining ETF. You must make the best
recommend whether it be a LONG or SHORT position, and you must
provide evidence to support your conclusion. Examine Chart 7-1: GDX. Do
you recommend a LONG or SHORT position in this security? (2 points)
26. Name and discuss the implication of the 2 most recent multi-day
candlestick patterns that support your conclusion (4 points each). For
each candle, comment if there is anything significant in the chart
that increases the strength of each candle pattern? (3 points each, 6
points total, 16 points total for question)
27. In Chart 7-1 how do the indicators Williams %R and ATR factor into
your analysis? (5 pts)

28. Determine how many shares can be traded (long or short), rounded to
the nearest 100 shares. Use Chart 7-1 and assume the following
conditions and demonstrate how you arrived at your answer:
 Trade entry price of $24.50 (long or short).
 Position risk limited to $15,000.
 Use ATR to calculate your stop price. Assume the last ATR reading is
.86. Use a factor of 1.5 in your ATR stop calculation. (4 points)
Chart 7-2
29. Examine the four labeled circles in Chart 7-2. In each circle there is a
multi-day candlestick pattern. Which circles contain formations that
are among those Bulkowski tested as most reliable? (2 points)
A) Circle 1 and 2
B) Circle 2 and 3
C) Circle 2 and 4
D) Circle 3 and 4
1
2
3
4

30. What is the name of the pattern you selected in question 7D? (2 points)
31. Having examined the fundamentals of the security in Chart 7-2, a
research firm just released an official “sell” recommendation on it
today. Comment on whether the provided indicators, MACD and
money flow, are “overbought” at their current levels. In your
opinion, do these indicators support the firm’s conclusion to sell the
stock today? In your answer, provide a brief definition of how each
indicator works. (11 points)

QUESTION #8: RISK MANAGEMENT (31 POINTS)
All technical analysis–based trading systems have a random component as
well as a predictive component. To make a trading system as robust as
possible, we must reduce the random component where possible during the
back-test-and-development phase, or what Aronson calls the data mining
bias. He defines the data mining bias as the expected difference between the
returns observed during the data mining phase (back testing) and its true
expected performance trading live in the future. Aronson defines five factors
that determine the magnitude of the data mining bias (Aronson, David R.,
Evidence-Based Technical Analysis, Chapters 5 and 6). Answer the following
questions regarding each of them.
32. The number of rules back tested. As the number of rules increases,
does the data mining bias increase or decrease? Explain one reason
why. (5 points)
33. The number of observations (the number of trades in the back test)
used to compute the performance statistics. Does more
observations (trades) increase the bias or decrease the bias? Explain
one reason why. (5 points)
34. Correlation among rule returns. Will five uncorrelated rules increase
or decrease the bias when compared to five highly correlated rules?
Explain one reason why. (5 points)
35. Percentage of positive outlier returns. Will return samples with fat
tails comprised of several extreme values increase or decrease the
data mining bias? Explain one reason why. (5 points)
36. Variation in expected returns among the various rules. If the
variation in return among the expected rules is low, is the data
mining bias lower or higher? Explain one reason why. (6 points)
37. Which of the five factors (above) is the most important in reducing the
data mining bias (randomness)? (5 points)

ANSWERS TO SECTION 1 - ETHICS
1. (D)
2. (A)
3. (C)
4. (C)
5. (C)
6. (B)
These questions reference the CFA Code of Ethics and Standards of
Professional Conduct found at this link:
http://www.cfapubs.org/doi/pdf/10.2469/ccb.v2014.n6.1

ANSWERS TO SECTION #2: BEHAVIORAL FINANCE
(25 POINTS)
7. (B)(C)(E)(F)(G)
(CMT III, Chapter 29)
8. If these conditions are broken, the group advantage is quickly lost:
1. People must be unaffected by others’ decisions (errors must be
uncorrelated).
2. Probability of being correct must be independent of the
probability of everyone else being correct.
3. Participants must be unaffected by their own vote possibly being
decisive.
1. Secret ballots
Reduces risk of social pressure. Come to meetings with views
prewritten or preference for asset allocation.
2. Devil’s advocate
It is a nice idea, but in order to be effective, the person needs to
actually believe the counterview.
3. Respect for other group members
Understand that other members are acknowledged experts in their
field. However, people tend to believe they know more than
others in almost every subject. This is especially prevalent in
financial services.
CMT III, p. 683

ANSWERS TO SECTION #3: ASSET RELATIONSHIPS
(31 POINTS)
9. (B)
10. Small-caps tend to lead large-caps coming out of bear markets.
(5 points)
Tech is typically an early cycle leader.
11. (A)
12. China is the world’s largest producer and consumer of copper.
13. (B) Chart 3-3
14. First, when the economy is weakening, filings for unemployment
insurance increase. (2 points)
Second the Chart 3-1 breakout shows this measure is undergoing a
meaningful trend adjustment. Economy may be transitioning from
the “full expansion” phase to the “early recession” phase of the
business cycle (2 points)
Utilities, Consumer Staples and Healthcare leading (Chart 3-1)
imply fundamental deterioration in business cycle. (2 point)
15. (B) Building Permits (New Private Housing), Displaced Moving
Average, Manufacturers New Orders
References for this section:
Learning Objectives: Identify leading, coincident and lagging indicators of economic activity.
CMT Level III 2017- Chapters 14, 17, 18, 19 and 21

ANSWERS TO SECTION #4: RISK MANAGEMENT
(35 POINTS)
16. Possible answers (4 points each for any answer specified below):
1. Only risk a small amount of total capital on any one trade: no
more than 5%.
2.Determine the maximum loss for the current trade in advance.
3. Exit a trade quickly.
4. Don't meet margin calls.
5. Liquidate your worst position first when lightening up.
6. Be consistent in your trading philosophy.
7. Be sure the trading profile is compatible with your risk preference.
8. Plan for contingencies. Be prepared for exceptions.
(CMT Level III, Chapter 12)
17. This method estimates the sampling distribution’s shape by randomly
resampling the original sample of observations so as to produce new
computer-generated samples. This in turn generates the P&L trade
data from a system from 100 to 2,000 times and generates an equity
curve for each simulation. If the great majority of the equity lines of
these 100 to 2,000 simulations are without substantial drawdowns
(beyond your acceptable threshold) and meet your profitability
requirements, then your portfolio system is probably robust. It is
more likely to be profitable and less likely to fail going forward.
18. 1. We can reduce the size of our trades or stop trading trend-
following systems completely if we use one of a variety of methods
designed to identify non-trending markets, such as ADX.
2. We can cut back on trading or stop trading trend-following
systems completely when our equity curve declines by a
predefined amount. Kirkpatrick and Dahlquist in CMT Level
III Chapter 2 page 48, wrote that a standard for closing the
entire portfolio model is a percentage stop, usually around
20%.

3. We can cut back on trading or stop trading trend-following
systems completely when our equity curve itself enters a
quantified and predefined downtrend.
19. In this question the error would be in the cells being referenced. This
graphic shows the CORRECT reference so you can know what it
SHOULD have looked like once it was fixed. The starting state of
that formula might have had, for example, the formula pointing to
cell B7 instead of B6, which would through off the numbers. Once
the numbers were properly configured, the correct answer among the
choices was (B) .41 and .49.
References:
(CMT Level III, Chapter 10, 12, and 23)

ANSWERS TO QUESTION #5: CLASSICAL METHODS
(40 POINTS)
20. Sell now.
1) Falling wedge pattern failure. Coffee prices failed to meet the
formulated price target of $220 (from the $220–$160 range
where $60 is height of the wedge). The high of the trend from
the subsequent pattern breakout was around $208. Bearish.
(CMT Level III, pg 1177)
2) The last day of Coffee price action traded below the PSAR
indicator, which is bearish.
(Kaufman, p. 790, CMT Level III pg 229)
3) The slow stochastic is still bearish from the last overbought
reading above 80 when the %K line crossed the %D line.
(CMT Level III pg 6)
4) Potential short-term double top. Coffee prices failed to rally above
the recent high at $208. Bearish.
(CMT Level III pg 1040)
Hold (wait).
Recent coffee price action is converging at four major support
levels:
1) At the lower Bollinger band level
2) At the Fibonacci 38.2% retracement level
3) At the MVWAP level
4) At the $175 price, which is short-term price consolidation support
between the recent two highs
(CMT Level III pg175)

21. Two signals that are supportive of a short position are
1. Rising prices on declining trade volume divergence.
2. Rising prices and declining RSI momentum divergence
Others may be possibly noted.
(CMT Level III pgs 5, 47, 48, 271)
22. Your predecessor recommended the firm enter the short position at
$125 and set a stop-loss at $130. If the firm had a fund of 5 million
dollars and wanted to take the trade and put only 1.5% of that
amount at risk, how many shares could be traded (assuming no loss
to gaps or slippage)? (12 points)
1.5% of $5MM is $75,000; therefore in order to contain your risk of
loss to that amount, the position size in 3M (MMM) should
be set at 15,000 shares sold short at the $125 price target
level.
(CMT Level III 473—Method of trades with equal initial position
risk)

(20 POINTS)
Examine Chart 6-1 (10-Year U.S. Treasury Prices).
23. Circle 4
(CMT Level III 932)
24. The very small body of the candle closed at the high point, well above
the lows earlier in the day. (4 points)
A named price pattern here such as long lower shadow, hammer, or
even dragonfly doji or any other bullish pattern would be
awarded extra. (5 points)
(CMT Level III 932–934)
25. Based on the fact the resistance line was broken and both closed near
the high (2 white candles above it) it is more likely that U.S. bond
prices will rise in the short term.
(CMT Level III 946)

(40 POINTS)
26. Long. (2 points, but if candidate selects “short,” 0 points)
Separating lines is the most recent pattern. (4 points)
For separating lines, one of the following counts:
This is a continuation pattern. (3 points)
Given the fact a window occurred before it and price action has now
crossed the moving average line, this increases the strength of
this bullish signal. (3 points)
Bullish engulfing is the next-most-recent pattern occurring around
Oct 15. (4 points)
For bullish engulfing, one of the following counts:
This is also reversal pattern, occurring near the bottom. (3 points)
The bullish engulfing candle engulfs two prior (small-body) candles,
increasing its significance. (3 points)
(Optional) Some candidates may suggest that a harami is present on
Oct 15. However, a bullish harami reversal needs to have a solid
black candle followed by a smaller candle (the second candle can be
white or black). (4 points)
(CMT Level III Chapter 32)

27. Williams is a momentum oscillator, like RSI or stochastics, but its scale
is inverted. It is at an extreme overbought reading of 10 right now,
and may be flattening out. (1 pt)
(CMT Level III 549)
However, this extreme reading does not always mean “sell.” If this is
the start of a new trend, since price action is now above the
moving average, a momentum oscillator can stay overbought
for a period of time as the trend continues. This occurred two
prior times in the chart. (2 pts)
(CMT Level III 549)
ATR helps to measure volatility. Volatility has been declining as the
security declined (in the last downtrend). There are a couple of
acceptable responses here:
1. Typically after a period of low volatility, volatility tends to
increase. Based on this chart, ATR is at its lowest range. Since the
security just broke above its moving average line, it is possible that
we will see increased volatility (but not confirmed yet).
2. ATR can be used as a breakout filter. If the breakout exceeds the
ATR level, it helps to confirm the breakout. In this case, the recent
break above the moving average with the gap is more than 86 cents,
helping to add validity to the breakout. (2 pts)

28. 1.5 times an ATR of 86 cents = $1.29. The stop would be placed $1.29
below the long entry price, at $23.21. (2 pts for correct explanation
of stop price).
Thus, rounding to the nearest hundred, a total of 11,600 shares could
be purchased at 24.50. (2 pts for correct number of shares)
29. (D)
Circle 3 contains a doji star, or a morning star, formation and Circle 4
contains a deliberation pattern, or more finely identified as an
advance block pattern, which consists of 3 successively smaller
white-bodied candles during an uptrend. Both are in the list of thop
15 Bullish Continuation patterns
CMT III, Chapter 32 p. 770
30. Advance block or deliberation (either is acceptable)
31. MACD cannot be “overbought” as it is not bound to a 0–100 scale, like
a typical oscillator. (2 pts)
It does not support the “sell” recommendation. (1 pt)
The 12- and 26-day moving averages continue to trend upward
above the zero (signal) line, with the faster average staying
above the slower one. There are no immediate signs of those
two averages crossing, showing continued upward strength.
(2 pts)
The Money Flow Index is considered “overbought,” as it is above
80. (2 pts)
This index is confined to a range between 0 and 100. However,
despite its high levels, it does not warrant an immediate “sell”
recommendation. Oscillators can stay in overbought territory
for some time in strong uptrends. (2 pts)
This oscillator accounts for the up days vs. the down days,
multiplied by daily volume. If a day’s average price is higher
than the previous day’s, then there is positive money flow. In
this case we see a continued uptrend in the Money Flow
Index (we don’t see a move back below the overbought line),
signifying that volume is also following the advances. (2 pts)
(CMT Level III 5)

ANSWERS TO QUESTION #8: RISK MANAGEMENT
(31 POINTS)
The general idea behind these questions is to address the idea of
randomness—less is good, and more is bad. Acceptable answers can
use any combination of random, randomness, predictable,
predictability, unpredictable, good luck, bad luck, data mining bias,
and other similar words.
32. Increases (2 pts)
As the number of rules increases, the chance that one set of rules will give
extraordinary results increases, increasing the odds of randomness.
The smaller the number of rules, the lower the odds that one set of
rules will stand out. (3 pts)
33. Decreases (2 pts)
The greater the number of observations (trades) used to compute the
performance statistics, the smaller the dispersion of the
statistic's sampling distribution. The more observations
(trades) that are in the sample, the lower the odds that a lucky
few will result in a high mean return. (3 pts)
34. Increase. (2 pts) Note: Uncorrelated rules will increase bias; correlated
rules will decrease bias. Both statements are acceptable.
A higher correlation among the rules has the effect of reducing the
number of rules, whereas a lower correlation has the effect of
increasing the rules. The more dissimilar the rules, the greater
the opportunity to have a great coincidental fit to the
historical data, and therefore very high performance due to
good luck. (3 pts)

35. Increase. (2pts)
Within a constant sample size, a greater number of extreme values
can create a large data mining bias. The size of the bias will
depend on how extreme the values are and how many
observations (trades) are in the sample. With a small sample
size, even one or two extreme positive values can
dramatically boost the sample mean. (3 pts)
36. Higher. (2 pts)
If the rules have approximately the same merit, the difference in
performance will be due primarily to luck. However, if one rule
begins to stand out statistically, it will be selected most of the time
since its predictive power is greater than the other rules, and
therefore its data mining bias is lower. (4pts)
37. The number of observations (trades) is the single most important factor
in reducing randomness. (5 points)
Acceptable references: law of large numbers, greater amount of
testing under variety of conditions, robustness in backtesting, etc.

CMT Level III Sample Exam Guide

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CMT Level III Sample Exam Guide