Forecasting of

Stock Market Price

Using Neural
Networks
Mudesira Munir
Managers must realize and accept the limitations of
forecasting and the uncertainty associated with all
forms of predictions; otherwise, unexpected results
and unpleasant surprises may await them. As long
as the patterns or relationships do not change,
forecasting will be accurate. The selection and
implementation of a proper forecasting
methodology has always been a planning and
control issue for most firms and agencies. This
thesis will suggest and describe the application of
Artificial Neural Networks for forecasting of stock
market closing prices.
Chapter #1

INTRODUCTION:
1.1 STOCK MARKET
A stock market is a public for the trading of company stock and derivatives at an
agreed price; these are securities listed on a stock exchange as well as those only traded
privately. The stock market has been one of the most popular investments owing to its
high returns.
The stocks are displayed and traded on stock exchanges which are entities of a
corporation or mutual organization specialized in the business of bringing buyers and
sellers of the organizations to a listing of stocks and securities together. The major stock
market in the America is NYSE while in Canada; it is the Toronto Stock Exchange
(TSX).
• Trading
Participants in the stock market range from small individual stock investors to
large hedge fund traders, Actual trades are based on an auction market model where a
potential buyer bids a specific price for a stock and a potential seller asks a specific price
for the stock. Buying or selling at market means you will accept any price (Bid or Ask)
for the stock, respectively. When the prices (Bid or Ask) match, a sale takes place, on a
first come first served basis if there are multiple bidders or askers at a given price.
The stock exchanges are built in order to facilitate buyers and sellers, thus
providing a marketplace. The stock exchanges provide Real Time trading system and
information for the listed securities.
• The behavior of the stock market
Positive or upward trends are referred to as bull markets; negative or downward
trends are referred to as bear markets. Over-reactions may occur so that excessive
optimism may drive prices unduly high or excessive pessimism may drive prices unduly
low. Forecasters continue to debate whether financial markets are generally efficient (EM
hypothesis).
According to one understanding of the efficient market hypothesis (EMH), only
changes in fundamental factors, such as the viewpoint for margins, profits or dividends,
ought to affect share prices beyond the short term, where random noise in the system data
may prevail. But this viewpoint known as hard EMH also predicts that little or no trading
should take place, contrary to fact, since prices are already at or near equilibrium, having
priced in all public knowledge. The hard efficient-market hypothesis is sorely tested by
such events as the stock market crash in 1987, when the Dow Jones index plummeted
22.6 percent the largest-ever one-day fall in the United States.
1.2 STOCK MARKET INDICES
Stock market indices are classified in many ways. A global stock market index
includes typically large companies without regard for where they are traded. The
examples are MSCI World and S&P Global 100.
Each country or nation has its own stock market index representing its
performance. The most commonly quoted market indices are national indices composed
of the stocks of large companies listed on a nation's largest stock exchanges, such as the
American S&P 500, the Japanese Nikkei 225, and the Karachi KSE 100.
The idea may be extended well beyond an exchange. The Dow Jones Total Stock
Market Index represents the stocks of nearly every publicly traded company in the United
States, including all U.S. stocks traded on the New York Stock Exchange (NYSE) and
mostly traded on the NASDAQ and American Stock Exchange (AMEX). More
specialized indices exist tracking the performance of specific sectors of the market.
1.3 INDEX VERSIONS
The indexes, such as the S&P 500, have many versions. These versions can vary
based on how the index components are weighted and on how dividends are accounted
for. For example, there are three (3) versions of the S&P 500 index: price return, which
only considers the price of the components, total return, which accounts for dividend
reinvestment, and net total return, which accounts for dividend reinvestment after the
deduction of a withholding tax.
1.4 MOST POPULAR AND LARGEST STOCK MARKETS:
1.4.1 American Stock Exchange (AMEX):
Today AMEX is one of the largest options exchanges in the United States.
1.4.2 New York Stock Exchange (NYSE):
NYSE is founded in 1792, the Big Board is the where the big companies have
shares. The NYSE is where companies such as Coca cola, McDonald's, General Electric
and Wal-Mart all trades. Whereas, America's largest companies and others, they all trade
on the NYSE.
1.4.3 NASDAQ
The most popular over-the-counter (OTC) market is the NASDAQ’s stock
exchange. This is a virtual exchange which has no central location or floor brokers as all
trading is done through a network of dealers. For many years, the largest companies
traded on the NYSE, while the second tier stocks traded on all the other exchanges.
Thanks to the dot-com boom of the late 1990's, some of America's largest firms trade on
the NASDAQ, including, Google, Microsoft, Cisco, Intel and Dell.
1.4.4 UNITED KINDOM:
The London stock exchange plays a vital role in maintaining one of the world’s
leading financial centers. The current LSE market includes not only the ordinary shares
of local and foreign companies and fixed interests securities issued by private borrowers
but also the primary and secondary markets in British government securities. At the end
of 2000, there were 2,428 domestic listed companies with the market capitalization of
1,812 billion pounds.
1.4.5 GERMANY:
There are eight technically independent stock exchanges in Frankfurt. However
they actually cooperate closely. Most recently the stock exchanges of Frankfurt,
Dusseldorf and Munich extended their cooperation in order to establish uniform pricing
mechanism for the DAX 100securities.
Recently the stock exchanges of Frankfurt, Dusseeeld offer the DAX 100securities .There
were 1088 domestic companies listed on the German stock exchange at the end of 2000.
1.4.6 CHINA:
China is the most populous country in the world and while its stock market is
currently rudimentary, given the recent growth and the potential growth of the Chinese
economy china’s stock market will inevitably be an important world stock market.
The Chinese stock market was divided into two types A-shares a, which are
restricted to Chinese investors and B-shares which were restricted to non-Chinese
investors. The A-share market was dominated in chines Yuan and was much larger than
the B-share The B-share market was started in 1991 to give private companies and
entrepreneurs access to foreign capital and give foreigners with hard currency
Shanghai B-shares are quoted in U.S dollars and Shenzhen B-shares are quoted in
Hong Kong dollars although these two currencies are linked.
1.4.7 JAPAN:
The Japanese stock market has a history of more than 120 years, beginning with
the establishment of the Tokyo stock exchange (TSE) in 1878. During the 1980 the
Japanese securities market changed substantially. Since March 2000, when the Hiroshima
and Niigata exchanges were merged with the TSE there have been six stock exchanges in
Japan.
OPERATIONS:
The TSE market is a continuous market where buy and sell orders directly
interact with one another. The trading of shares is carried out under the zebra method
which is similar to an open outcry method. Prices are first established at the beginning of
the trading session based on orders placed by regular members before the start of the
trading. The central book is kept by satori members who function solely as intermediaries
between the regular members. They are not allowed to trade any listed stock for their own
account or to accept orders from the investing public. After the opening price is
established satori members match.
1.5 FORECASTING STOCK MARKET:
Recently forecasting stock market return is gaining more attention, maybe
because of the fact that if the direction of the market is successfully predicted the
investors may be better guided and also monetary rewards will be substantial. If any
system which can consistently predict the trends of the dynamic stock market be
developed, would make the owner of the system wealthy. Another motivation for
research in this field is that it possesses many theoretical and experimental challenges.
The most important of these is the efficient market hypothesis (EMH) which proposes
that profit from price movement is very difficult and unlikely. In an efficient market,
stock market prices fully reflect available information about the market and its
constituents and thus any opportunity of earning excess profit ceases to exist any longer.
So it is ascertain that no system is expected to outperform the market predictably and
consistently.
In the approach used in this paper, the ANN will be the signal generator, and its
output will be used to either initiate or exit trades. Rules to enter and exit trades are based
on the strength of the ANN output signal.

1.5.1 Application of Neural Networks to Market Prediction

Neural networks are very effective when lots of examples must be analyzed, or
when a structure in these data must be analyzed but a single algorithmic solution is
impossible to formulate. When these conditions are present, neural networks are use as
computational tools for examining data and developing models that help to identify
interesting patterns or structures in the data. The data used to develop these models is
known as training data. Once a neural network has been trained, and has learned the
patterns that exist in that data, it can be applied to new data thereby achieving a variety of
outcomes.
The ability of neural networks to discover nonlinear relationships in input data
makes them ideal for modeling nonlinear dynamic systems such as the stock market.
Various neural network configurations have been developed to model the stock market.
Commonly, these systems are created in order to determine the validity of the EMH or to
compare them with statistical methods such as regression. Often these networks use raw
data and derived data from technical and fundamental analysis discussed previously. This
thesis wills overview the use of neural networks in financial markets including a
discussion of their inputs, outputs, and network organization. Also, any interesting
applications of theoretical techniques will be examined. For example, many networks
prune redundant nodes to enhance their performance. The networks are examined in three
main areas:
1. Network environment and training data
2. Network organization
3. Network performance
1.5.2 Training a Neural Network
A neural network must be trained on some input data. The two major problems in
implementing this training discussed in the following sections are:
1. Defining the set of input to be used (the learning environment)
2. Deciding on an algorithm to train the network
1.5.3 The Learning Environment
One of the most important factors in constructing a neural network is deciding on
what the network will learn. The goal of most of these networks is to decide when to buy
or sell securities based on previous market indicators. The challenge is determining
which indicators and input data will be used, and gathering enough training data to train
the system appropriately.
The input data may be raw data on volume, price, or daily change, but it may also include
derived data such as technical indicators (moving average, trend-line indicators, etc.) or
fundamental indicators (intrinsic share value, economic environment, etc.). The input
data should allow the neural network to generalize market behavior while containing
limited redundant data.
Determining the proper input data is the first step in training the network. The second step
is presenting the input data in a way that allows the network to learn properly without
overtraining. Various training procedures have been developed to train these networks.
1.5.4 Network Training
Training a network involves storing input patterns in a way so that the system
minimizes its error and improves its performance. The training algorithm may vary
depending on the network architecture, but Back Propagation algorithm is the most
common training algorithm used when designing financial neural networks. This section
describes some of the training techniques and their associated challenges in some
implemented systems.
The most common network architecture for financial neural networks is a
multilayer feed forward network trained using Back Propagation. Back Propagation is the
process of backpropagating errors through the system from the output layer towards the
input layer during training. Back Propagation is an important algorithm because hidden
units have no Training Target value that can be used, so they must be trained based on
errors from previous layers. The Output layer op back Propagation algorithm is the only
layer which has a Target value for which to compare.
As the errors terms are BackPropagated through the nodes, the connection
weights are changed. Training Procedure occurs until the errors in the weights are small
enough to be accepted. It is interesting to note that the type of activation function (such as
threshold, sigmoid) used in the neural network nodes can be a factor on what data is
being learned.
The major area of consideration in training a neural network is deciding when to
stop training. Since the ability to generalize is elementary for these networks to predict
future stock prices, overtraining is a serious problem.
Overtraining occurs when the system memorizes patterns and thus loses the ability to
generalize. It is an important factor in these prediction systems as their primary use is to
predict or generalize on input data that it patteronized. Overtraining can occur by having
too many hidden nodes or training for too many time periods (epochs). However,
overtraining can be prevented by performing test and train procedures or cross-validation.
The test and train procedure involves training the network on most of the patterns
(usually around 90%) and then testing the network on the remaining patterns. The
network’s performance on the test set is a good indication of its ability to generalize and
handle data it has not been trained on. If the performance on the test set is poor, the
network configuration or learning parameters can be changed. The network is then
retrained until its performance is satisfactory. The quantity of training data is also
important. Ideally, it is desirable to have as much training data as the system can be
feasibly trained with.
1.6 Research Purpose:
Testing and training of neural networks will be performed over the stock market
data in order to specify a neural network’s ability to predict future trends of Stock Market
Indices. It will then analyze the use of neural network as a forecasting tool. Finally, the
probability of the model’s forecast being correct will be calculated using conditional
probabilities. While only briefly discussing neural network theory, this research will
determine the feasibility and practicality of using neural networks as a forecasting tool
for the individual investor.
The research describes the methodology required to build, train, and test a neural network
using software. In this research, an S&P500, NASDAQ, DOW Jones etc. network model
was validated using available data. Finally, and potentially most importantly for the
investor, model accuracy probabilities were generated. This was done by combining
historical market movement probabilities with the model accuracy probability. This
conditional probability could prove to be a vital tool for investment decision making. The
entrance of the neural network as an investment tool for the individual investor was one
of the many things brought about by the explosive growth personal computers. .
It was concluded that neural networks do have the capability to forecast financial markets
and, if properly trained, the individual investor could benefit from using this forecasting
tool.
CHAPTER # 2
LITERATURE REVIEW
Forecasting of stock market returns is an important issue in finance. Nowadays
artificial neural networks (ANNs) have been popularly applied to finance problems such
as stock exchange index prediction, bankruptcy prediction and corporate bond
classification. An Artificial Neural Network model is a computer model whose
architecture essentially mimics the learning capability of the human brain.
The elements of an Artificial Neural Network resemble the biological structure of
neurons and the internal operation of a human brain. Many simple interconnected
elements that may use threshold or sigmoid function are operating in parallel processing
at multiple layers. In some applications it has been specified that ANNs have limitations
for learning the data patterns. They may perform inconsistently and unpredictable
because of the complex financial data used. Sometimes data is so voluminous that
learning patterns may not work. Continuous and large volume of data needs to be
checked for redundancy and the data size should be decreased for the
algorithm to work in a shorter time and give more generalized solutions

There are several motivations for trying to forecast stock market prices. The most
basic of these is financial return. Any software system that can constantly pick winners
and losers in the dynamic market place would make the owner of the system very
wealthy. Thus, many individuals including researchers, investment professionals, and
average investors are continually looking for a software system which will yield them
high returns. There is another motivation in the research and financial communities. The
Efficient Market Hypothesis effectively states that no system can continually beat the
market because if this system becomes public, everyone will use it, thus negating its
potential gain. There has been an ongoing debate about the validity of the Efficient
Market Hypothesis, and some researchers attempted to use neural networks to validate
their claims. There has been no consensus on the Efficient Market Hypothesis validity,
but many market observers tend to believe in its weaker forms, and thus are often
unwilling to share proprietary investment systems. [16]
Neural networks (ANN’s) are used to predict stock market prices because they are able to
learn nonlinear mappings between inputs and outputs. Contrary to the Efficient Market
Hypothesis, several researchers claim the stock market and other complex systems
exhibit chaos. Chaos is a nonlinear deterministic process which only appears random
because it cannot be easily expressed. With the artificial neural networks (ANN) ability
to learn nonlinear, chaotic systems, it may be possible to outperform traditional analysis
and other computer-based methods. [16]

Neural networks can be used to learn to predict future events based on the
patterns that have been observed in the historical training data; learn to classify unseen
data into pre-defined groups based on characteristics observed in the training data;
learn to cluster the training data into natural groups based on the similarity of
characteristics in the training data.

2.1 PROCESS OF A BACKPROPAGATION

Back propagation algorithm

The Back propagation algorithm seeks to minimize the error term between the
outputs of the neural net and the actual desired output value. The error term is
calculated by comparing the net output to the desired output and is then fed back
through the network causing the synaptic weights to be changed in an effort to
minimize error. The process is repeated until the error reaches a minimum value. [6]

In a forward pass the outputs are calculated and the error term at the output units
calculated. And in a backward pass, the output unit error is used to alter weights on
the output units. Then the error term at the hidden nodes is calculated by back-
propagating the error at the output units through the weights, and the weights on the
hidden nodes altered using these values.
2.2 BACK PROPAGATION LEARNING ALGORITHM

The major steps of the back propagation learning algorithm are given below:

1. Input data to be train.

2. Hidden nodes calculate their outputs.

3. Output nodes calculate their outputs on the basis of Step 2.

4. Calculate the differences between the results of Step 3 and targets.

5. Apply the first part of the training rule using the results of Step 4.

6. For each hidden node in a hidden layer, n, calculate d(n). (derivative)

7. Apply the second part of the training rule using the results of Step 6.

Steps 1 through 3 are often called the forward pass, and steps 4 through 7 are often
called the backward pass.

For each pair of data to be learned a forward pass and backwards pass is performed.
This is repeated over and over again until the prediction error is at a low enough level.
 start

Intilialize
Learning rate
Momentum

Assigns input and

output signals

Adjust weights

No

Compute Hidden Compute output

Output target stop
layers layers
yes

Figure 2.1: Flow Graph for the Neural Network

 2.3 Calculations and Transfer Function:

The behavior of a NN (Neural Network) depends on both the weights and the
input/output function or transfer function that is specified for the units. This function
typically falls into one of three categories:

 Linear

For linear units, the output activity is proportional to the total weighted Wij output.

 Threshold

For threshold units, the output are set at one of two levels, depending on whether the
total input is greater than or less than some threshold value.

 Sigmoid

For sigmoid units, the output varies linearly but not continually as the input changes.
Sigmoid units accept a greater resemblance to real neurons than do linear or threshold
units, but all three must be considered rough approximations.

The network uses Equation 1 to update the weight Wij from a given node i N to the
current node j N ; where t refers to the number of times the network has been updated
and ‘l’ refers to the learning parameter. The learning parameter, or learning rate,
controls the rate the weight is changed as learning takes place. The sensitivity of
node j N to a change in weight Wij is represented by W ije and will be defined more
fully below.
Ii = ∑WijOi + θ
Oi = 1 / 1 + e-i
OUTPUT LAYER:
Errj = Oj (1-Oj)(Ij – Oj)
 HIDDEN LAYER:
Errj = Oj (1-Oj)∑ ErrWij
Also , Bias and weight changes are as follows
∆θ = L Errj
∆Wij = L Errj Oi

Figure 2 .2: Back Propagation

2.4 REVIEW
CHAN Man-Chung, WONG Chi-Cheong, LAM Chi-Chung [8] collect daily
trading data of eleven companies in 1994-1996 from Shanghai Stock Exchange for
technical analysis of stock price. The first 500 entries were used as training data. The
remaining 150 were testing data. The raw data is preprocessed into various technical
indicators to gain insight into the direction that the stock market may be going. Ten
technical indicators were selected as inputs of the neural network. [8]
The training phase of a back propagation network is an unconstrained nonlinear
optimization problem. The goal of the training is to search an optimal set of connection
weights in the manner that the errors of the network output can be minimized. [8]
 Besides popular steepest descent algorithm, conjugate gradient algorithm is
another search method that can be used to minimize network output error in conjugate
directions. [8]
Backpropagation is a difficult technique. It runs the risk of being trapped in local
optimum. The starting node of the connection weights becomes an important issue to
reduce the possibility of being trapped in local optimum. Random weight initialization
does not guarantee to generate a good starting point. It can be enhanced by multiple linear
regressions. In this method, weights between input layer and hidden layer are still
initialized randomly but weights between hidden layer and output layer are obtained by
multiple linear regression. [8]
EMA is a trend-following tool that gives an average value of data with greater
weight to the latest data. Difference of EMA can be considered as momentum. RSI is an
oscillator which measures the strength of up versus down over a certain time interval.
High value of RSI indicates a strong market and low value indicates weak markets.
MACD, a trend-following momentum indicator, is the difference between two moving
average of price.
In order to avoid difficulty in getting network outputs very close to the two
endpoints, the indicators were normalized to the range of [0,1], before being input to the
network. [8].
Empirical results have shown that Neural Networks outperform linear regression.
Since stock markets are complex, nonlinear, dynamic and chaotic. Neural networks are
reliable for modeling nonlinear, dynamic market signals. [8]
Birgul Egeli, Meltem Ozturan, and Bertan Badur [9] performed research on
Turkish stock market. Network architecture is chosen is Multi-Layer Perceptron and
Generalized Feed Forward networks. Testing and training is performed using these two
network architectures. The results are then compared with the results of moving
averages (MA) for 5 and 10-day time periods, which showed that artificial neural
networks (ANN) have better performances than moving averages. [9]

2.5 MODELING OF STOCK MARKET INDEX VALUE

 The ANNs can effectively be used to predict the Stock Exchange using index
values S&P 500 Index. Supervised learning models have been utilized in which certain
output nodes were trained to respond to certain input patterns and the changes in
connection weights due to learning caused those same nodes to respond to more general
classes of patterns.

2.5.1 DATA SETS

Experimental data were gathered by using commercial software for USA starting
from March 10, 2010 to April 20, 2010. From this data set, the first 7 cases (about 90%)
were taken as training and remaining as testing examples.
2.5.1 NETWORK PARAMETERS
For the system model described before, Artificial Neural Network model is
applied with random number of hidden layers (For e.g. HL = 1, 2, 4) for Learning rate
input by the investor /user for the data set.
2.5.1.1 Momentum
The momentum parameter controls how much of the previous weight adjustment
is applied to the current weight adjustment. As larger values are used for momentum, the
greater the influence of the current correction term, relative to previous correction terms.
Momentum can also be used to provide a smoothing effect for weight adjustments [15].

2.5.1.2 Training Rate

Training rate also known as Learning Rate determines the amount of the
correction term applied to adjust neuron weights. A small value for training rate tends to
increase learning time and decrease the probability of overshooting an optimal solution.
A small value also increases the likelihood of being stuck in local minima. Large values
for training rate increase the chance of no learning occurring at all. [15]

2.6 TRAINING RESULTS

 In this study, ANN models were applied to the system model, using an ANN
software package. ANN models’ performances can be measured by the coefficient of
determination (R2) or the mean relative percentage error. This coefficient of
determination is a measure of the accuracy of prediction of the trained network models.
Higher R2 values indicate better prediction. The mean relative percentage error may also
be used to measure the accuracy of prediction through representing the degree of scatter.
[9]

2.7 SELECTION OF TECHNICAL VARIABLES

The selection of technical variables for input to the technical neural network is
influenced by the technical variables discovered during the formal literature review Stock
market indicators such as moving averages, stochastic oscillators, RSI etc are used By
Nikhil Bakshi Stock [12].
The ANN performances can be compared with Moving Averages (MA) approach
for example. The moving average is the average of lagged index values over a specified
past period ------------- (25 and 50 days in this study). The mean relative percentage errors
were calculated as -----------days.
2.8 SYSTEM MODEL
Using historical data, a neural network can be learned that describes how trading
signals are related to subsequent price movements. The trained neural network can then
be applied to new data to predict future price movements and make investments. [12]
2.8.1 Hidden Layer
One hidden layer is used with a configurable number of neurons. A regular sigmoid
function is used as a transfer function.
2.8.2 Output
The output is the expected price change in a window of days. The value is in the
continuous [0,1] range with 1.0 representing a 10% rise, 0.5 representing no price change
and 0.0 representing a 10% price drop.

2.8.3 Training
The neural network's weights are learned using the backpropagation algorithm with a
configurable learning rate and number of epochs. [12]
The input variables were the highest and lowest prices paid during the day, the
closing price. The output variable used in this study was prepared according to the
direction of the index on the following day. The closing price is first normalized by the
investor using Min-Max Normalization using the scale [0, 1]. Then data is loaded for the
input of Neural Network.
For the purposes of this study, all data relating to an index (the highest and lowest
prices paid during the day and the closing price) was obtained from using the
commercially available software the NEURO Stock master. [10]
CHAPTER # 3
RESEARCH METHODOS / DESIGN
3.1 The Research Questions
The following research questions allow the research to meet the objectives proposed:
 What is the mathematical theory behind the Back propagation neural network?
 Can neural networks accurately forecast a stock market index?
 Can neural networks be used as a practical forecasting tool by individual
investors?
Conduct a literature review of books magazines and World Wide Web on the topic of
neural networks Identify the mathematical theory of the back propagation neural
networks. . Select a Stock Index to make forecasts upon. Determine what to forecast
and the future point for the forecast variable Days. Determine the inputs to the neural
network assemble the historical input data and preprocesses it using MS Excel.
3.1 DATA FLOW DIAGRAM OF SOFTWARE:

Data Sources

2 3
Data collection
Extraction of Data
1
data Cleaning

Database
Administrator

4
User/Programmer Database
Nasdaq Or
Apply Neural Network S&p 500

5
Stock
Data mining
market
Tools table

Load Data
Normalize data 6
Time Series Analysis
 Figure 3.1 Data Flow Diagram

3.2 ER_DIAGRAM OF DATABASE USED TO STORE INPUTS:

Date Open Buy Sell

High Id

Id StocK Qoutes Buy/Sell Buy/Sell Date

Volume
Low
Close

Figure 3.2 Database Design

3.3 CLASS DIAGRAM OF SOFTWARE:

Neuron
+ThresholdValue Connection
+LastInputValue *
-Weight
+SigmoidFunction() -PreviousWeight
+SigmoidfunctionPrime() *
+GetSumOfInputWeigths()
+Output()

1 NeuralNetwork
+MaxIterations
Layer +LearningRate
+Momentum
-LastOutputValues +RandomMin
+Output * +RandomMax
+Learn()
+Output()
+Randomize()
-CalculateErrors()
-UpdateWeights()

Figure 3.3 Class diagram of the system

 Neuron class represents the artificial neuron, the basic structure of a neural
network. It carries a threshold value, has input values, uses a sigmoid function and
combination of those properties are used to calculate the overall output. Neurons are
connected to each other with connection lines which carry weights, represented by the
Connection association class. Neurons reside in layers, so the Layer class represents the
artificial layer where a layer contains one to many neurons and a neuron can only reside
in one layer. Therefore, the relationship between a neuron and a layer is one-to-many.
The neural network, which is represented by the Neural Network class, has parameters
like Max Iterations, Learning Rate, and Momentum and consists of several layers.
Therefore, the relationship between Neural Network and Layer classes is one-to-many.

The training algorithm is backpropagation and the threshold function used in artificial
neurons is the sigmoid function. The program is developed as a library package so that it
can easily be used.
3.4 USE CASE DIAGRAM

Insert Update Delete

<<include>> <<include>>
<<include>>
Database Administrator

Stock Market Database

Relative strength index

<<Extends>>

Tmieseries Forecast <<Extends>> Money flow index

User/programmer <<Extends>>
Stochastic Oscillator
Investor

Normalize data Save all data to an CSV

<<include>>

Figure 3.4 Use Case Modeling of software designed

 In addition to stock market prediction, neural networks have been trained to
perform a variety of financial related tasks. There are experimental and commercial
systems used for tracking commodity markets and futures, foreign exchange trading,
financial planning, company stability, and bankruptcy prediction. As the application of
neural networks in the financial area is so vast, this paper will focus on stock market
prediction.  In stock trading, there are typically two methods used to determine whether
to buy or sell a stock fundamental analysis and technical analysis.

Fundamental analysis in forecasting stock market prices is used to evaluate the

intrinsic value of the underlying asset of the stock by examining related economic and
company-specific information. Technical analysis is used to forecast and identify patterns
in stock prices from historical prices and the traded volume of the stock. Due to the
widely available dataset of accurate historical prices (open, high, low and close) and the
volume traded, this project will focus on these as inputs to the Neural Network. The
following indicators, which are derived from historical prices and commonly used in
technical trading, are also included as inputs to the NN: simple moving average,
exponential moving average, moving average convergence divergence, relative strength
index, and stochastic oscillator. Finally, although neural networks are used primarily as
an application tool in the financial environment, several research improvements have
been made during their implementation. Notable improvements in network design and
training and the application of theoretical techniques are demonstrated by the
examination of several example systems.

3.6. ANALYTICAL METHODS

Before the advent of computer, traded stocks and commodities primarily on

intuition. As the level of investing and trading grew, people searched for tools and
methods that would increase their gains while minimizing their risk. Statistics, technical
analysis, fundamental analysis, linear regression is all used to attempt to predict and
benefit from the market’s direction. None of these techniques has proven to be the
consistently correct prediction tool that is desired, and many analysts argue about the
usefulness of many of the approaches. However, these methods are presented as they are
commonly used in practice and represent a base-level standard for which neural networks
should outperform. Also, many of these techniques are used to preprocess input data, and
their results are fed into neural networks as input. [11]

3.6.1 FUNDAMENTAL ANALYSIS

Fundamental analysis involves the in-depth analysis of a stock company’s

performance and portability to determine its share price. A method of evaluating a
security level that entails attempting to measure its intrinsic value by examining related
economic, financial and other qualitative and quantitative factors. Fundamental analysts
attempt to study that can affect the security's value, including macroeconomic factors
(like the overall economy and industry conditions) and company-specific factors (like
financial condition and management). 
The  goal of performing fundamental analysis is to produce a value that an investor can
compare with the security's current price, with the aim of figuring out what sort of
position to take with that security value (underpriced = buy, overpriced = sell or short
notpriced =hold).
This Fundamental analysis is considered to be the opposite of technical analysis. 

The advantages of fundamental analysis are its systematic approach and its ability
to predict changes before they show up on the charts. Companies are compared with one
another, and their growth prospects are related to the current economic environment. This
allows the investor to become more familiar with the company. Also, it is hard to time the
market using fundamental analysis. Although the outstanding information may warrant
stock movement, the actual movement may be delayed due to unknown factors or until
the rest of the market interprets the information in the same way. However, fundamental
analysis is a superior method for long-term stability and growth. Basically, fundamental
analysis assumes investors are 90% logical, examining their investments in detail,
whereas technical analysis assumes investors are 90% psychological, reacting to changes
in the market environment in predictable ways. [11]
3.6.2 TECHNICAL ANALYSIS

The idea behind technical analysis is that share prices move in trends dictated by
the constantly changing attitudes of investors in response to different forces. Using price,
volume, and open interest statistics, the technical analyst uses charts to predict future
stock movements. Technical analysis rests on the assumption that history repeats itself
and that future market direction can be determined by examining past prices. Thus,
technical analysis is controversial and contradicts the Efficient Market Hypothesis.
However, it is used by approximately 90% of the major stock traders. Despite its
widespread use, technical analysis is criticized because it is highly subjective. Different
individuals can interpret charts in different manners.

Price charts are used to analyze trends. Trends are assumed to be based on supply
and demand issues which often have cyclical or wave patterns. There are a variety of
technical indicators derived from chart analysis which can be formalized into trading
rules or used as inputs to neural networks. Some technical indicator categories include
filter indicators, momentum indicators, trend line analysis, cycle theory, volume
indicators, wave analysis, and pattern analysis. Indicators may provide short or long term
information, help identify trends or cycles in the market, or indicate the strength of the
stock price using support and resistance levels.

An example of a technical indicator is the moving average. The moving average

averages stock prices over a given length of time allowing trends to be more visible.
Several trading rules have been developed which pertain to the moving average. For
example, "when a closing price moves above a moving average a buy signal is
generated."[11]. unfortunately, these indicators often give false signals and lag the
market. That is, since a moving average is a past estimate, a technical trader often misses
a lot of the potential in the stock movement before the appropriate trading signal is
generated. Thus, although technical analysis may yield insights into the market, its highly
subjective nature and inherent time delay does not make it ideal for the fast, dynamic
trading markets of today.

3.7 Classification of Indicators

Indicators are mathematical/statistical functions that are applied over stock properties
such as close, high, low and volume. These Indicators are broadly classified into the
following important categories:
 Market Momentum Indicators
 Market Volatility Indicators
 Market Trend Indicators
 Broad Market Indicators
 General Momentum Indicators
The following are some of the basic indicators that are used for creating the baseline
model. These indicators are known to provide useful information for forecasting using
neural networks.
3.7.1 Relative Strength Index
Relative Strength Index is a measure of the strength that is intrinsic in a field and is
calculated using the amount of upward and downward price changes over a given period
of a time. It has arrange of 0 to 100 with values typically remaining b/w 30 and 70 .The
formula for computing Relative strength Index is as follows
RSI=100-[100/ (1+RS)]
Where RSI=Relative strength Index
RS=Average of x days up closes average of x days closes.
In addition, the value is defined 100 when no downward price changes occur during the
period of calculation.
 Relative Strength Index usually leads by the price by forming peaks and valleys
before the price data, especially around the values 30 and 70.
 When the RSI diverges from the price, the price eventually follows a corrective
trend towards the direction of the Index.
3.7.2 Money Flow Index
Money Flow Index is a measure of the strength of the monetary investment flowing into
or out of a stock traded in the open market. It is principally derived by comparing the
volume of upward and downward price changes over a given period of time. The money
flow Index is based on the quantity of Money Ratio, which is the ratio of positive money
flow to negative money flow over the given period of time.
Money Flow=Typical Price * Volume
Money Ratio= Positive Money Flow
Negative Money Flow
MFI=100 - 100
1+Money Ratio
Positive Money Flow is defined as sum of prices multiplied by the volume on
days when the price increases. Negative Money flow is defined similarly, except that it
includes only days when the prices decreases. The Money Flow Index typically has the
range of 0 to 100 with values rarely exceeding the bounds 20 and 80.
3.7.3 Stochastic Oscillator
The stochastic Oscillator may be defined as a measure of the difference between the
current closing price of a security and its lowest low price, relative to its highest high
price for a given period of a time.

The value is a percent rating for the closing price, relative to the trading range b/w
its recent highest and lowest prices. A value of zero indicates that the security had a
closing price at its lowest recent low. A value of 100 indicates it that the security had a
closing price at its highest recent high. The value is often smoothed using a slowing
period to eliminate noise in the trend graph. It is used in technical analysis.

3.7.3.1 Interpretation

The idea behind to use this indicator is that prices tend to close near their past highs in
bull markets, and near their lows in bear markets. Transaction signals can be spotted
when the stochastic oscillator crosses its moving average.

Two stochastic oscillator indicators are typically calculated to assess future variations in
prices, a fast (%K) and slow (%D). Comparisons of these statistics are a good indicator of
speed at which prices are changing or the Impulse of Price.  %K is the same as Williams
%R, though on a scale 0 to 100 instead of -100 to 0, but the terminology for the two are
kept separate.

The fast stochastic oscillator or Stoch %K calculates the ratio of two closing price
statistics: the difference between the latest closing price and the lowest price in the last N
days over the difference between the highest and lowest prices in the last N days:

Where:
CP is closing price
LOW is low price
HIGH is high price

3.7.4 Moving average Convergence /divergence (MACD)

The MACD is the difference b/w the short and long term moving averages for a field
.The MACD is generally a specific instance of a value Oscillator and is mostly used on
the closing price of a security to detect price trends .When the MACD is on an increasing
trend, prices are trending higher. If the MACD is on decreasing trend, prices are trending
lower.

3.7.5 Moving Averages:

Moving Average is calculated by averaging together the previous values over the given
period, including the current value.
MA = Σ Closing Price
n

Moving averages are useful for eliminating noise in raw data. Analysis of the moving
average of the price yields a more general picture of the underlying trends.
3.7.6 Simple moving average

A simple moving average (SMA) is the un weighted mean of the previous n data
points. For example, a 10-day simple moving average of closing price is the mean of the
previous 10 days' closing prices. If those prices are then the
formula is

When calculating successive values, a new value comes into the sum and an old
value drops out, meaning a full summation each time is unnecessary,

Perhaps the simplest of all Time series forecasting techniques is a moving aver-
age. To use this method, we calculate the average of, say, three periods of actual demand
and use that to forecast the next period's demand. If this three-period average is to be
used as a forecast, it would have to forecast demand in a future period. [14]

Because each average moves ahead one period each time, dropping the oldest
value and adding the most recent, this procedure is called a moving average. The number
of periods to use in computing the average may be anything from 2 to 12 or more, with 3
or 4 periods being common. If the time series is such that there is no upward or
downward trend, then the moving average is a satisfactory technique. If, how-ever, there
is any trend or any seasonal effect, then the moving average will not work very well.
Moving averages lag behind any trends.

3.8 BASIC FORECASTING TECHNIQUES

Forecasting techniques (APPLIED IN THIS THESIS) can be divided into two

categories: qualitative and quantitative. The former, which involve numbers, uses
methodology that is not mathematical. Qualitative techniques rely on judgment, intuition,
and subjective evaluation. Among the major techniques within this category are market
research (surveys), Delphi (panel consensus), historical analogy, and management
estimation (guess).
3.8.1Qualitative Techniques
Commercial packages are also a reference for comparison of the results of the
software developed. Several commercial neural network packages are widely used in
Artificial Neural Network studies, one of which is Neuro Stock master1.3, for USA.
This section discusses the techniques used to develop the neural network and
multiple regression financial forecasting models. The combination of these models, with
historical and conditional probabilities, will allow the investor to make decisions based
on probabilities of success. The presentation first discusses the development of the
models, followed by the historical probability calculations and concludes with the
conditional probability calculation. The information to be forecast was first identified.
Three separate indexes were chosen, the first was the S&P 500 and predicted on last 15
bars. Accurate forecast is possible when predicting the percent change versus the actual
closing value of a stock or index. For example, if the S&P500 index is calculated from
date 22-07-08 to 04-05 10(chart #1) Open value in 25-01-10 was 1092.4 and closing
value 1096.78.
In moving simulation, prediction is done while moving the target learning and
prediction periods. For example, initially the system is trained on data from January,
tested on data for February, and then used to predict data for March. In the next iteration,
the system trains on the February data, tests on the actual March data, and then predicts
data for April. In this way, the system is continually updated based on the most recent
data and its performance is improved.
The first neural network model, named S&P 500 Index *SPX the inputs to the model
where developed by first downloading the following raw data from Dial Data using Data
Downloader software:
 S&P 500 Index

 NASDAQ

 Dow Jones Industrial Index

The data set encompassed the different trading days. The data was charted using
stock charting software called STOCK NEUROMASTER 1.33. This established date
integrity within each index. Using Microsoft Excel, each index text file was combined
into one spreadsheet. The resulting file was formatted such that each index and its date
were in a separate column with each row representing a trading day.
 An example of a partial data set can be found in Appendix B. Date integrity is
extremely important to the neural network. To ensure integrity was maintained, each
index’s date column was checked for integrity against the S&P500 date using a simple “if
then” rule in Excel. If the dates were equal, it placed a zero in a row. If the dates were
not equal, Excel placed a 1 in a row. This function was copied down the entire data set
and then summed at the bottom. A sum of zero represented no date integrity
discrepancies.
Prediction statistics for buy, sell and hold are also tabulated separately
[APPENDIX A]
 S&P 500 Index

 NASDAQ

 Dow Jones Industrial Index

This (CHART) represents the future closing price of the S&P500 Index and was the
actual value the network used to compare against its prediction during training. This
future information was created by simply copying the S&P 500 closing price into the last
column of the spreadsheet deleting the first 10 days of data and moving the remaining
data up 10 rows. Once this was complete, all date columns were deleted with the
exception of the one associated with the S&P 500 data. The file was saved as an Excel 4
worksheet so it could be imported into NEUROSTOCK MASTER. .

The following data was imported into the neural network software package as a
pattern file:
S&P500 O NASDAQ O DOW Jones O
S&P500 H NASDAQ H DOW Jones H
S&P500 L NASDAQ L DOW Jones L
S&P500 V NASDAQ V DOW Jones V
S&P500 C NASDAQ C DOW Jones C
3.8.2 Quantitative Technique:
When attempting to forecast demand for a new item, one faces a shortage of
historical data. If the there is no special event data is very similar, quantitative techniques
may be used. But if the relationship is vague, it may be more appropriate to relate the
products only qualitatively in order to get an impression of demand patterns or aggregate
demand. [1]
Chapter # 4
COLLECTION OF DATA AND IMPLEMENTAION
Software Tools:
Software Tools required for the implementation of the software:
1. Microsoft Visual C # 2005 Express Edition
2. AForge.net Framework 2.1.2 version
3. Microsoft Access 2003-2007
4. Microsoft Windows XP 2007

Include Libraries:

 AFoge.Neuro.dll
 AForge.Controls.dll
 AForge.dll

Include Sources:

 Core
 Control
 Neuro

Algorithm:

 BackPropagation
 Time series
Figure 4.1 Input variables to ANN
Figure 4.2 Stock Quotes Database View
Figure 2.3 Normalization
Figure 2.4 Money Flow Index
Figure 2.5 Stochastic Oscillator
 Figure 2.6 Relative strength indexes

The data collected by using an available software as a sample for S&P

500, Nasdaq’s and Dow Jones for open, high, low, close and volume .Buy sell is also
indicated in separate tables .The bar graphs are also plotted in order to analyze time series
forecasting using the software designed in order to validate the ability of Neural
Networks ability to forecast the stock Market Prices.
S &P 500:

Table 4.1

NASDAQ:
Table 4.2
Table 4.3
DOW

Table 4.4
Table 4.5
Graph 4.1
Graph 4.2
Graph 4.3
Chapter # 5
Analysis
The learning rate (training rate) was set to ---0.1&0.2---and the momentum was
set to ---0 or 0.1----. Within the Training Criteria module, pattern selection was set to
random, calibration interval was set to every random patterns and stopping criteria was
set to stop training at --1000--events since minimum average error within the test set.
Within the training module, the network was set to automatically save the weights for the
best test set. The network was then trained within the Training module. The trained
network was then applied to the ----2----sample test patterns.
A testing period to find a suitable model for the problem area is observable due to
the lack of methodologies for use in the development of an Artificial Neuron Network
Model. An intuitive Approach is needed for the architecture in order to develop a suitable
model and develop parameters relating to the training statute. Backpropagation seems fit
for the time series Analysis and is an effective model in the prediction of Stock Exchange
Market S&P 100 Index. Training was not realized in some of the ineffective models, with
a resulting failure to decrease the percentage of the error in the network. In some cases,
the network memorized the data, resulting in an observable tendency to decrease the
percentage of error in the training data, while increasing the percentage of error in the test
data. All ineffective models were eliminated, and as a result, the model, parameters given
above, found the training data to be----80 to 88----% in 2 Or 3 iterations.

No of testing Data Points 25

 No of correct change predictions 22
No of incorrect change predictions 3
Percentage Accuracy 88%
Learning Rate & Momentum 0.1 & 0
Table 5.1

No of testing Data Points 45

No of correct change predictions 38
No of incorrect change predictions 7
Percentage Accuracy 84 %
Learning Rate & Momentum 0.2 & 0.1
Learning Error 0.268
Table 5.2
Chapter #6
CONCLUSION & DISCUSSIONS
Everybody wants to know whether the stock market will be up or down
tomorrow. Marketing analyst want to predict future sales. Economists want to predict
economic cycles. Banks can use neural networks to scan credit and loan applications to
estimate bankruptcy probabilities, while money managers can use neural networks to plan
and construct profitable portfolios in real-time.
It is to expect that ‘Time series Forecaster” can be improved to make
predictions with greater accuracy in the following ways:
 Including more selective fundamental factors, technical indicators, and broader
market indices into the input data set.

 Fine tuning and proper training the network topology and learning parameters.

This thesis has attempted to analyze the Artificial Neural Networks

ability to forecasts stock market prices. In doing so, it has laid down a structured
approach to creating trading systems using neural networks, and has defined the key
characteristics necessary to benchmark these trading systems tested on out-of-sample
data. Backpropagation neural network is employed during this thesis, focusing on
different sets of input variables, and they were trained and tested over different portions
of the market. The purpose of this section of the thesis is to provide a discussion on why
the neural networks achieved the results they did, and then to formally draw conclusions
about the research question and thesis hypotheses from the results. Another possible
explanation is that the neural network did not perform poorly, and that it gave good
signals, however, these signals were not focused enough to allow a trading system to
profit. This implies that when the market is rising, many stocks tend to benefit and
participate in this rise. By implication, when the overall market is listless for a prolonged
period, any strategy which relies on exploiting abnormal returns has limited its scope for
success.
Function profiles are excellent tools to visually inspect the profile of any mathematical
function. They allow a deep and visual understanding of functions characteristics, and
provide the ability to visually assess the function profile in varying timeframes
simultaneously. Their main limitation becomes apparent when considering the function
profile for the poorly performing Artificial Neural Networks. This limitation is that the
function profile is not contextual. In other words, for a given output strength forecast by
the Artificial Neural Networks, the average return displayed in the function profile is the
average return of all the observations for that output strength.
This thesis has effectively attempted to document and explain the
forecasting stock market return anomalies by using separate Artificial Neural Networks
trained with fundamental and technical data.
It was noted in the literature review that there is a growing trend towards
using the ensemble approach to analysis amongst soft-computing researchers.

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