2024 CMT LEVEL III:

The Integration of Technical Analysis

Learning Objective Statements
Sample Questions

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 Level III: Learning Objective Statements
A list of Learning Objectives appears at the beginning of each chapter in the CMT Level III text. These are
intended as a guide to the most important concepts discussed in the chapter and they are prime material for the
exams. The following is a chapter-by-chapter list of the CMT Level III Learning Objectives.

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Section One: Risk Management

1 System Design and Testing

Assess the value and challenges of using a system for trading or investing
Compare and analyze differences between discretionary and nondiscretionary systems
Evaluate the mind-set and discipline required to develop and trade with a system
Organize the basic procedures for designing a system
Inventory types of technical trading systems
Defend the necessity of risk management protocols in a trading system
Examine critical aspects of performing system tests
Compare and evaluate standard measures of system profitability and risk
Differentiate between various methods of optimization

2 Money and Portfolio Risk Management

Distinguish between trading strategies and money-management strategies
Evaluate the significance of the theory of runs and a martingale strategy
Model position size using risk of ruin and optimal f methods
Differentiate between diversifiable and correlated risk
Compare and analyze the various types of stops used to manage risk
Assess the minimum capital needed for trading a system

3 System Evaluation and Testing

Choose factors for system testing including objectives, parameters and test data
Assess the use of in-sample and out-of-sample data
Evaluate optimized test results for continuity and significance using a variety of visualization methods
Explain the basics of using genetic algorithms
Illustrate the concept of robustness in a trading system
Critique the use of performance and risk metrics based on a given objective

4 Practical Considerations
Plan for system development and testing: data, techniques, and initial evaluation of results
Assess the potential impact of price shocks and formulate plans for managing them
Assess the impact of runs and martingales on a trading system
Evaluate the trade-offs between trend-following and mean-reverting systems

5 Risk Control
Compare risk and performance metrics derived from the following: Sharpe Ratio, Information Ratio, Treynor
Ratio, Calmar Ratio, Sortino Ratio
Interpret calculations of Value at Risk (VaR)
Model position size using various capital and volatility approaches in this chapter
Compare various methods for setting stops and profit targets
Compare approaches to compounding positions
Calculate the risk of ruin
Calculate optimal f

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6 Statistical Analysis
Assess random and nonrandom trends in trading system performance
Examine sampling and sample statistics in trading
Calculate relative frequency
Organize six elements of a statistical inference problem
Differentiate between theoretical and empirical probabilities
Derive a sampling distribution

7 Hypothesis Tests and Confidence Intervals

Differentiate between necessary and sufficient conditions
Compare the assertions of the null and alternative hypotheses
Defend why the null hypothesis should be framed as the target of a test
Prepare the data and arrange the steps for a Monte Carlo simulation

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Section Two: Asset Relationships

8 Regression
Assess values generated by regression, multiple regression and tolerance calculations
Select meaningful predictor variables for multiple regression studies based on correlation values among them and
with the dependent variable

9 Gold
Compare general correlations among gold, dollar, stocks, and indexes

10 Intermarket Indicators
Construct relative strength studies and evaluate the results
Compare intermarket indicators described in this chapter
Prepare recommendations based on asset correlation data

11 A Unique Way to Visualize Relative Strength

Evaluate the trend and momentum of relative strength using Relative Rotation Graphs (RRGs)
Assess relative strength using the indicators derived from the RRG concept

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Section Three: Portfolio Management

12 Fact, Fiction and Momentum Investing

Defend the use of momentum strategies using historical data
Argue against common myths about momentum strategies

13 Analyzing the Macro-Finance Environment

Assess the business cycle, the financial cycle, and their relationship
Manage a sector rotation model based on the business and financial cycles
Use leading, coincident, and lagging indicators of economic activity

14 Portfolio Risk and Performance Attribution

Assess the statement “total risk = volatility = standard deviation of returns”
Compare the three formulations of total risk
Defend the assertion that “diversification reduces only firm-specific risk”
Defend beta and its role in assessing portfolio risk
Employ the Sharpe and Treynor ratios for individual stocks and portfolios

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Section Four: Behavioral Finance

15 Behavioral Biases
Distinguish between two types of biases: cognitive and emotional
Formulate plans to counter behavioral biases in making investment decisions
Propose methods to capitalize on the behavioral biases of other market participants
Examine the specific behavioral biases in each of those categories

16 Investor Psychology
Inventory general behavioral aspects that impact price action
Evaluate behavioral elements that contribute to the development of chart patterns
Evaluate behavioral elements that contribute to the persistence of trends
Evaluate behavioral elements that contribute to periods of consolidation
Evaluate behavioral elements that contribute to trend reversals

17 Are Two Heads Better than One?

Assess the negative consequences of group/committee decision making
Organize approaches to mitigating the effects of group biases

18 The Anatomy of a Bubble

Diagram the five stages of a bubble
Assess the characteristics of each of the five stages
Assess hypothetical market environments to identify what stage they indicate

19 De-Bubbling: Alpha Generation

Assess the three cross-section strategies that should benefit from a de-bubbling/deflationary period

20 Behavioral Techniques
Evaluate market reactions to events: planned news releases versus price shocks
Estimate reactions to events using the volatility ratio
Assemble a COT Index and a COT Sentiment Index from Commitments of Traders (COT) data

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Section Five: Volatility Analysis

21 The VIX as a Stock Market Indicator

Compare movement in the VIX and the S&P 500
Evaluate VIX and VIX futures price relationships for signals
Formulate market forecasts that include volatility as an input

22 Hedging with VIX Derivatives

Defend the rationale behind hedging with VIX products
Propose hedge strategies using VIX options and futures

23 Advanced Techniques
Assess the relationship between price and volatility
Compare several measures of volatility
Calculate profit targets and stop-loss levels using volatility
Evaluate methods for filtering a system’s signals based on volatility
Assess how fractal, chaos, and entropy concepts may be applied to trading
Explain the basics of using neural networks
Explain the basics of using genetic algorithms

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Section Six: Classical Methods

24 Pattern Recognition
Compare and evaluate pivot points and DeMark’s calculations for price ranges
Examine intraday data for idiosyncratic patterns in various markets
Assess the use of opening gaps as trading signals

25 Multiple Time Frames

Evaluate chart data using Elder’s and Pring’s multiple time-frame methods
Defend Krausz’s six rules for multiple time frames

26 Candlestick Analysis
Evaluate the strengths and weaknesses of candlestick charts
Categorize reversal and continuation candlestick patterns
Interpret the nine important price action guidelines
Assess the significance of various Japanese candlestick patterns to pinpoint reversals and breakouts
Integrate candlestick charts with other technical studies

27 Progressive Charting
Evaluate candle patterns as they develop in a chart
Compose responses to the four questions posed at the outset of the chapter

28 Bringing it All Together: Real-World Charts

Predict likely price action based on candlestick patterns and the overall context of the price action
Propose entry and exit points based on patterns, price action, and risk
Assess trend persistence based on candlestick patterns and the overall context of the price action

29 Conclusions
Assess the validity of the 12 major conclusions about technical indicators the authors present
Defend the use of technical indicators when properly employed in a variety of market environments

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 Level III: Sample Questions
The following sample CMT Level III questions offer a glimpse into the style and scope of the exam. These samples
are by no means a study guide; instead, consider them a taste of what a Level III candidate may be asked to
show mastery of the body of knowledge.

Important points to note --

 The CMT Level III exam tests the candidate’s ability to integrate a wide range of concepts and tools into
the application of technical analysis.

 The exam is delivered on a computer in Prometric testing facilities, or through Prometric’s ProProctor
remote-proctoring service. Please be sure to schedule your exam well in advance.

 The CMT Association has adopted the CFA Institute Code of Ethics and Standards of Professional Conduct
(“Code and Standards”) as its ethics guide. Questions on the Code of Ethics and Standards of
Professional Conduct appear on all three levels of the CMT exams. The Standards of Practice Handbook
is a valuable study guide for the Code and Standards. Please use those documents as ethics are not
otherwise included in the CMT Program textbooks.

 Candidates have four hours to complete the exam.

 The Level III exam is organized into groups, most of which weave together two or more knowledge
domains. In turn, each of those groups contains from three to seven items requiring a response. Some
items will be multiple choice; most will be short answer and require that you make a list, state and justify
your analysis, or supply a similar written response.

 The exam is marked on a scale of 240 points. The point value of each section and item is given. The point
values are also meant to reflect the time it might take to supply an answer. That is, a section worth 30
points is estimated to require 30 minutes to complete. Of course, you may be faster or slower on various
sections but the point values are still a useful guide in your time management.

Advice for candidates sitting for the CMT Level III exam --

 Supply the answer that the question calls for. Your grade will be based on answering the question, not
on showing off or trying to distract the graders.

 Resist the temptation to over-answer. If the question asks for “three reasons,” then supply three
reasons. Graders are instructed to look only at the first “three reasons” (or however many the question
calls for). Your time is best spent thinking and checking, rather than simply cramming more into the
response.

 If you cannot fully answer a question, supply at least the part you know. That is, if the question calls for
supplying “three reasons” but you can supply only two, then write those two reasons. Graders have
leeway to grant partial credit.

 Spelling and grammar and sentence structure are NOT graded. Please do your best to communicate the

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information. The Association and the graders do not grade for presentation or style, and we know that
English is not the first language for many candidates. We work to keep the language in the questions
direct and consistent and it is best for you to do the same in your responses.

© 2024 CMT Association, Inc.

Classical Methods, Risk Management, Volatility – 40 points

You are an investment adviser helping a client understand the construction of their portfolio. This client is
interested in getting your technical perspective on two stocks: Facebook (FB) and ExxonMobil (XOM).

Examine the charts of both stocks. Each chart is a long-term daily candle chart with 50- and 200-day moving
averages (blue and red, respectively), as well as the stock's relative strength versus the S&P 500.

Chart 1 - FB

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Chart 2 - XOM

1. Review Charts 1 and 2 and identify which stock is the most attractive from a classical technical
standpoint? (5 points)

A. Facebook
B. ExxonMobil

2. Using the chart of the stock you selected in question 1, describe three pieces of technical
evidence that justify your answer. (6 points)

3. From a risk-management standpoint, think about how you would recommend entering this
trade. Describe what buy condition and what stop loss appears warranted based on the chart. (6 points)

4. Your client wants to risk no more than 2% of his $100,000 portfolio on this trade. Assuming your
client is determined to use a stop 7% below the stock's current price, calculate the maximum dollar
value he should allocate to this first position (round to the nearest dollar). (8 points)

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Rather than buy a single stock, your client has decided to invest his entire portfolio into both Facebook and
ExxonMobil, equally weighted. You begin to tabulate the following data to help him understand and manage the
investment risks involved:

Stock Mean (ExpectedReturn) Standard Deviation (σ)

FB 41.084 35
XOM 12.88 10.8
50% FB/ 50% XOM Portfolio 26.982 19.003

Correlations
FB XOM
FB 1.00 0.0979
XOM 0.0979 1.00

5. What does standard deviation (σ) represent in the table above? (3 points)

6. How is it different from popular indicators like the VIX? (6 points)

7. While the expected return of the 50/50 portfolio is simply the average of the expected return of
the two stocks, the standard deviation doesn't keep that same relationship. Explain why not? (6 points)

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Answers
1.
A. Facebook

2.
• Shares are testing new highs.
• Shares are above both moving averages.
• The 50-day moving average has crossed back above the 200-day moving average.
• Facebook just broke out of an inverse head and shoulders pattern.
• Shares have made a series of higher lows over the course of the chart.
• Facebook's long-term uptrend is still intact.
• Facebook's relative strength line is in an uptrend.
• Both moving averages are in an uptrend.

3.
It makes sense to either:
• Buy a breakout above Facebook's recent highs (at ~$134)
• Or, wait for a retracement to trendline support. Logical stops include:
• Violation of most recent swing low/uptrend at ~$115.
• 200-day moving average

4.
$100,000 * 0.02 = $2,000 risk per position.
$2,000 ÷ 7% stop loss = $28,571 position size.

5.
Volatility of returns, or risk.

6.
Standard deviation is different from the VIX because it is a statistical measure of observed volatility,
while the VIX Volatility Index is a statistical measure of implied volatility.

7.
Because the correlations between FB and XOM are low. The lower the correlations (and covariances),
the greater the opportunity to reduce portfolio volatility – in this case, standard deviation. This is an
example of the risk-reducing benefits of diversification.

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Portfolio Management, Behavioral Finance, Asset Relationships - 25 points

A popular asset allocation newsletter, called Alpha-Edge, warns of the probability of a stock market bubble. In
the article, the author offers the following advice: “Investors looking to reduce volatility and add downside
protection should begin to shift equity holdings to more defensive assets, like fixed income and gold.”

1. The newsletter is recommending going long bonds. Which type of inflation would likely cause
the author’s expected correlation of equities to bonds to be the least accurate? (2 points)

A. Deflation
B. Stagflation
C. Disinflation
D. Hyperinflation

2. Should the type of inflation in the prior question occur, and is forecast to last for a period
greater than a year, would you recommend being LONG gold? Why or why not? Your answer must
include two distinct points from the assigned readings. (7 points)

3. Examine Table 1 below. As part of its evidence, the Alpha-Edge newsletter calls attention to US
corporate financials. Based on the trends in US corporate GDP and liabilities, what market stage are we
likely in? (2 points)

A. Euphoria
B. Critical stage
C. Displacement
D. Credit creation

Table 1
Period of Study US Corporate Real GDP% Change US Corporate Liabilities %
from Preceding Quarter Change from Preceding
Quarter
Oct 2016 – Dec 2016 1.8 2.0
Jan 2017 – Mar 2017 1.6 2.5
Apr 2017 – Jun 2017 1.9 2.4
Jul 2017 – Sep 2017 2.0 3.4
Oct 2017 – Dec 2017 1.7 4.1

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 4. One of the main premises of the newsletter is that a buy and hold, value-oriented investing
approach typically outperforms momentum trading strategies over the long run. Part of the author’s
rationale is due to the tax issues incurred from higher portfolio turnover. Cite two specific reasons why
momentum investing may not be as tax disadvantageous as the newsletter states. (4 points)

For questions 5 and 6: Consult the following two exhibits:

• Table 2 provides data on a 3-position portfolio (20% Gold mining ETF, 30% Gold commodity, and 50% in
the S&P 500).
• Chart 1 of GDXJ (Junior Gold Mining ETF).

The Alpha-Edge newsletter cites: “Consider adding gold mining stocks to your portfolio to diversify our gold
commodity investment recommendation. The included chart (GDXJ) shows an ETF that holds a variety of mining
companies, which are traditionally very volatile. However, in the past six months, notice that prices have traded
in a narrower band. This indicates that adding this security to your US Equity portfolio would help to increase
the Sharpe Ratio, a key metric used for evaluating risk and reward.”

5. Consult the chart of GDXJ. The newsletter is using Average True Range on the GDXJ chart as a
measurement for future implied volatility. Do you agree with this and why? How is ATR typically used by
technical analysts? (4 points)

Chart 1

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 6. Examine the table of the three-position portfolio. Discuss one benefit and one disadvantage
when using the Sharpe Ratio as the means of determining risk and reward in the recommended
portfolio? (6 points)

Table 2
Standard Deviation Expected Return Sharpe Ratio
GDXJ 8 12.0 1.15
GOLD 7 9 1.02
SPX 13 6.4 .98
20/30/50 Portfolio 10.4 9.7 1.29

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Answers
1.
A. Deflation

2.
No
 While a weakening dollar can strengthen gold prices, recent data shows that gold has been more
positively correlated to the equity markets.
 While being long gold can provide defense for the short-term (the fear trade) it is typically not a
good longer-term investment (compared to equities).
 The seasonality of gold, due to the varying holiday demand by jewelers, causes price changes
(supply/demand).

3.
A. Euphoria

4.
 Momentum trading tends to hold winners longer than losers.
 Momentum tends to have lower divided yield exposure vs value (or tax optimization is easier to
control through capital gains/losses vs dividend income).

5.
No
 ATR is a measure of a security’s volatility against itself, BUT it doesn’t predict future volatility.
 Typically, ATR is used to help establish risk levels (stop prices).

6.
One of the following negative rationales. The Sharpe Ratio does not account for:
 consecutive small losses/gains
 the order in which gains or losses occur
 large surges of profits and losses
 One of the following positive rationales. The Sharpe Ratio helps:
 to quantify reward for a unit of risk
 to show the value of diversifying different positions, vs holding just one.
 risk-averse investors, who will prefer to own a portfolio with a higher Sharpe ratio than owning
individual securities.

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© 2024 CMT Association, Inc.