Noesis
Level 2 — RecallWhat to Trade

What to Trade

⏱ 30 minutes40 marksprintable — key stays hidden on paper

Subject: Stock-Market
Chapter: What to Trade
Difficulty Level: Level 2 — Recall (definitions, standard problems, short derivations)
Time Limit: 30 minutes
Total Marks: 40

Instructions

Answer all questions. Show working where calculations are required. Use ...... for any mathematical expressions.

Q1. Define a liquid stock and state any two characteristics that distinguish it from an illiquid stock. (4 marks)

Q2. State the full form of F&O and name the two main types of derivative instruments traded in the F&O segment. (3 marks)

Q3. Nifty 50 and Bank Nifty are two commonly traded indices. Briefly explain what an index represents and state one key difference between Nifty 50 and Bank Nifty. (4 marks)

Q4. Define relative strength in the context of comparing a stock to its sector or benchmark index. Explain what it means when a stock is a "sector leader." (4 marks)

Q5. In currency pair trading, a quote is written as USD/INR = 83.20. (a) Identify the base currency and the quote currency. (2 marks) (b) If the pair moves from 83.20 to 83.45, state whether the INR has strengthened or weakened against the USD, with reason. (3 marks)

Q6. List four filters/criteria a trader could use while screening stocks for intraday trades. (4 marks)

Q7. The correlation coefficient between two instruments is ρ=−0.85\rho = -0.85. (a) State whether the instruments are positively or negatively correlated. (1 mark) (b) Interpret the strength of this relationship. (2 marks) (c) Explain one practical use of correlation for a trader building a portfolio. (2 marks)

Q8. Define a watchlist and give two reasons why a trader maintains one. (4 marks)

Q9. State two distinguishing features of commodity trading compared to equity trading. (4 marks)

Q10. A trader compares two stocks over a month:

  • Stock A returns +8%+8\% while its sector index returns +5%+5\%.
  • Stock B returns +2%+2\% while the same sector index returns +5%+5\%.

Which stock shows positive relative strength and which shows relative weakness? Justify with a one-line calculation of the return spread. (4 marks)

Answer keyMark scheme & solutions

Q1. (4 marks)

  • Definition (2 marks): A liquid stock is one that can be bought or sold quickly and in large quantities without significantly affecting its market price, owing to high trading volume and many active buyers/sellers.
  • Two characteristics (1 mark each):
    1. High daily traded volume.
    2. Narrow bid-ask spread. (Also acceptable: many active market participants, easy entry/exit, low slippage.) Why: Liquidity = ease of conversion to cash at fair price; volume and tight spread are the primary observable signals.

Q2. (3 marks)

  • Full form of F&O = Futures and Options (1 mark).
  • Two instruments: Futures (1 mark) and Options (1 mark). Why: These are the two core derivative contract types whose value derives from an underlying asset.

Q3. (4 marks)

  • Index meaning (2 marks): An index is a basket of representative stocks whose combined weighted value tracks the overall performance/movement of a market or sector.
  • One difference (2 marks): Nifty 50 tracks the 50 largest, diversified companies across sectors on the NSE, whereas Bank Nifty tracks only banking-sector stocks (sectoral index). Why: Nifty = broad market gauge; Bank Nifty = narrow sectoral gauge, hence more volatile.

Q4. (4 marks)

  • Relative strength definition (2 marks): A measure comparing the performance (return) of a stock against its sector or a benchmark index; if the stock outperforms the benchmark it has positive relative strength.
  • Sector leader (2 marks): A stock that consistently outperforms its sector/peers and often leads the sector's price moves; it shows the strongest relative strength within its group. Why: Traders prefer leaders because strength tends to persist.

Q5. (5 marks)

  • (a) Base currency = USD (1); Quote currency = INR (1). Why: In USD/INR the first-named currency is the base, second is the quote.
  • (b) INR has weakened (1). Reason: it now takes ₹83.45 instead of ₹83.20 to buy 1 USD, so more rupees are needed per dollar (2). Why: A rising USD/INR rate = depreciation of INR.

Q6. (4 marks, 1 each — any four) Acceptable filters: daily volume/liquidity, price range/volatility (ATR), % gainers/losers, market capitalization, price above/below moving average, RSI level, gap-up/gap-down, sector/relative strength, F&O availability. Why: Screening narrows the universe to tradable, liquid, moving candidates.

Q7. (5 marks)

  • (a) Negatively correlated (1). Why: ρ<0\rho < 0.
  • (b) ∣ρ∣=0.85|\rho| = 0.85 is strong — the instruments tend to move in opposite directions most of the time (2).
  • (c) Use for diversification / hedging — pairing negatively correlated instruments reduces overall portfolio risk since one rises when the other falls (2).

Q8. (4 marks)

  • Definition (2 marks): A watchlist is a curated list of stocks/instruments a trader monitors closely for potential trading opportunities.
  • Two reasons (1 each): (i) Focus attention on a manageable set of quality candidates; (ii) Quickly spot setups/entry signals in real time. (Also: track sector leaders, organize by strategy.)

Q9. (4 marks, 2 each) Acceptable distinctions:

  • Commodities involve physical goods (gold, crude, agri) with contracts often physically deliverable or cash-settled, vs equities representing company ownership.
  • Commodity trading has different exchanges/timings (e.g., MCX, extended hours), influenced by global demand-supply, geopolitics and currency, unlike company-specific fundamentals for stocks. Why: Different underlying, drivers, and market structure.

Q10. (4 marks)

  • Return spread = Stock return − Sector return.
  • Stock A spread =8%−5%=+3%= 8\% - 5\% = +3\% → positive relative strength (outperforms) (2 marks).
  • Stock B spread =2%−5%=−3%= 2\% - 5\% = -3\% → relative weakness (underperforms) (2 marks). Why: Relative strength is judged by out/under-performance versus the benchmark, not absolute return.
[
  {"claim":"Stock A relative strength spread = +3%","code":"spread_A = 8 - 5\nresult = (spread_A == 3)"},
  {"claim":"Stock B relative weakness spread = -3%","code":"spread_B = 2 - 5\nresult = (spread_B == -3)"},
  {"claim":"USD/INR rising 83.20->83.45 means more rupees per dollar (INR weaker)","code":"result = (83.45 > 83.20)"},
  {"claim":"Correlation -0.85 is negative and strong (|rho|>0.7)","code":"rho = -0.85\nresult = (rho < 0) and (abs(rho) > 0.7)"}
]