Statistical & Quantitative Methods Flashcards
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Read the first 7 Statistical & Quantitative Methods flashcards as text
Why do technical analysts use a logarithmic (semi-log) scale on long-term price charts?
Answer: To represent equal percentage price changes as equal vertical distances on the chart
A logarithmic scale plots equal percentage changes as equal vertical distances, making long-term comparisons meaningful by ensuring a 10% move looks the same at any price level.
What does a Monte Carlo simulation provide in the context of trading strategy analysis?
Answer: A probability distribution of possible strategy outcomes based on random sampling of historical returns
Monte Carlo simulation randomly samples from historical return data thousands of times to generate a probability distribution of possible outcomes, quantifying strategy risk and performance variability.
What is the primary purpose of 'walk-forward' testing when validating a technical trading system?
Answer: To validate optimized system parameters on rolling out-of-sample periods that follow the optimization window
Walk-forward testing optimizes parameters on an in-sample window then tests on the subsequent out-of-sample period, repeating this process forward through time to simulate real-world conditions.
How does the 'random walk hypothesis' challenge the premise of technical analysis?
Answer: It posits that price changes are essentially random and independent, making past prices unable to predict future prices
The random walk hypothesis states that price changes are serially independent and random, which, if true, would mean historical price patterns cannot consistently predict future price movements.
What is the key advantage of a Weighted Moving Average (WMA) over a Simple Moving Average (SMA)?
Answer: A WMA assigns linearly increasing weights to more recent prices, making it more responsive to current price action
A Weighted Moving Average assigns linearly increasing weights to more recent data points, giving the current period the highest weight and making the WMA more sensitive to recent price changes than an SMA.
What does the concept of 'regression to the mean' suggest about extreme price deviations?
Answer: After significant deviations from historical average levels, prices tend to revert back toward the mean over time
Regression to the mean is the statistical tendency for extreme values to move back toward the historical average over time, suggesting that unsustainably extended prices tend to normalize.
In hypothesis testing applied to trading strategy backtests, what is the distinction between a Type I and a Type II error?
Answer: A Type I error is a false positive (wrongly rejecting a true null hypothesis); a Type II error is a false negative (failing to reject a false null hypothesis)
A Type I error (false positive) occurs when a true null hypothesis is incorrectly rejected, while a Type II error (false negative) occurs when a false null hypothesis is incorrectly retained.