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You are on page 1of 6

Industrial background:

Ionospheric research at EISCAT

Riga workshop 28-29/11 1997

Thomas Hellstrm

- Optimisation and Control computers for ferries

- Real time data analysis

Common viewpoints

Types of in and out data

Prediction as Inductive Learning

Performance evaluation

Mlardalens hgskola.

The work I will present is done in collaboration with

Kenneth Holmstrm

Thomas Hellstrm 1997

Stock time series?

Common viewpoints

Looks very much like random walk!

The process is regime shifting. The markets move

in and out of periods of ''turbulence'', ''hause'' and

''baise'. Hard for traditional algorithms!

The evaluation of predictability is extremely hard!

When have we learned and when have we

memorised?

The prices reflect ALL available information and new

information is assimilated immediately.

Implies a random walk. Impossible to predict!

Traders viewpoints

Just a question of hard work and good intuition!

The market clearly goes through periods of positive

and negative trends. Its just to identify the peaks and

the troughs

+

A successful prediction algorithm does not have to

give predictions for all points in the time series.

Can we predict predictability?

3

7 50

7 50

7 00

7 00

6 50

6 50

6 00

S tock price

S tock price

6 00

5 50

5 00

4 50

5 50

5 00

4 50

4 00

Lower Break out SELL!

4 00

3 50

3 50

3 00

3 00

2 50

0

100

200

300

4 00

da y nu m b e r

5 00

6 00

70 0

2 50

0

5

100

200

300

4 00

da y nu m b e r

5 00

6 00

70 0

6

Ooops!

of pure random walk.

0.4

7 50

0.35

0.3

7 00

P(R<r)

6 00

Dow Jones 1984-1996:

Mean=0.05% Std. dev.=1.1

0.25

6 50

0.2

0.15

S tock price

0.1

5 50

0.05

5 00

0

-6

Random walk

4 50

3 50

3 00

2 50

0

100

200

300

4 00

da y nu m b e r

5 00

6 00

-2

0

2

Daily change r (%)

r P(R<r)

0 5.00E-01

-1 2.00E-01

-2 4.00E-02

-3 4.00E-02

-4 2.00E-04

-5 4.00E-06

-6 5.00E-08

-7 3.00E-10

-8 6.00E-13

-9 7.00E-16

4 00

-4

70 0

7

Question:

How often can we expect a crash like

november 1987 (-28% in one day) ?

0

1063

0

201

0

56

1

19

23

9

982

3

88244

3

20,000,000

1

7000,000,000

1

6000,000,000,000

1

Close price

Highest payed during day

Lowest payed during day

Volume (no. of traded stocks)

9

Thomas Hellstrm 1997

10

Thomas Hellstrm 1997

inflation

interest rates

trade balance etc.

p/e: Stock price divided by last 12 months earning

per share

Book value per share: Net assets (assets minus

liabilities) divided by total number of shares

Net profit margin: Net income divided by total sales

Debt ratio: Liabilities divided by total assets

Prognoses of future profits

Prognoses of future sales

Other stock's prices, normally presented as

indexes.

The prices of related commodities such as oil,

metal prices and currencies

The value on competitors stocks

Thomas Hellstrm 1997

11

12

Derived entities

Derived entities

k-day Returns:

y(t)

y(t) - y(t k)

log

y(t k)

y(t k)

R k (t) =

V=

y( t )

ln y(t 1) m

t =1

where

m=

z( t )

1

N1

1 k

y( t i)

k i=1

13

1

N

y( t )

ln y(t 1)

t =1

14

Inductive Learning

Inductive Learning

The case of Prediction:

E = (e 1,...e N ) where

e t = e(g( X (t)), z( t + h ))

vector E: E = (e1,...e N )

where e i = e( g(x i ), z i )

I.e: g should approximate f

Note:

The error function e and the norm |E| are still not defined.

Thomas Hellstrm 1997

1)

Inputs, i.e. The X vector

Output, i.e the z vector

Error function e(g(x), z)

Vector norm for computing E = (e1,...e N )

Bias for g (prior knowledge of g)

Thomas Hellstrm 1997

15

I.e Predict future prices with past prices

Two Hidden layers with 3 and 5 nodes

Output layer with 1 output node

et = g(X(t)) z(t + h)

E =

N-h

1

Nhk +1

e

t =k

2

t

16

y(t)

y(t-1)

(RMSE)

g( t )

y(t-2)

y(t-3)

k

g(t) =

i= 0

y(t - i)

Thomas Hellstrm 1997

AR-model

E =

Neural network

17

N -1

1

N 4

(g

( t ) y( t + 1)) 2

t=4

18

1)

Inputs: X ( t ) = ( R 1( t ), R 5 ( t ), R 10 ( t ), R 20 ( t ) )

Output: z( t + 5 ) = R 5 ( t + 5 )

Drawbacks:

A stationary model is not realistic

Fixed horizon not realistic. A profit 2 days ahead is

as good as 1 day ahead.

threshold 0

e t = 1 g( X(t)) < AND z(t) > 0

0 otherwise

large as equal.

E =

1

N

2

t

t =1

if g( X(t) ) >

buy

T(t) = sell

if g( X(t) ) <

do nothing otherwise

19

Two Hidden layers with 3 and 5 nodes

Output layer with 1 output node

R1( t )

R5 (t)

20

gw (t)

The hidden layer stores previous values and can

reconstruct the dynamics

gw (t)

y( t )

R 10 ( t )

R 20 ( t )

E =

N-5

1

N 24

E =

2

t

t = 20

21

N -1

1

N 4

(g

( t ) y( t + 1)) 2

t=4

Technical Indicators

22

Technical Indicators

Can often be described as a trading rule:

if g( X (t) ) >

buy

T(t) = sell

if g( X (t) ) <

do nothing otherwise

The trending nature of prices

Volume mirroring changes in price

Support/Resistance

Example:

Examples:

Moving averages

Formations such as triangles

RSI - the relation between the average upward price

change and the average downward price change

within a time window normally 14 days backwards

Thomas Hellstrm 1997

23

z( t )

1 k -1

y( t i)

k i= 0

v( t ) v( t ) v( t 1)

Thomas Hellstrm 1997

24

5 0 a n d 1 0 0 d a y m o vin g a ve ra g e s

180

Portfolio management

Minimise the variance in a portfolio by quadratic

programming

Also possible with single stock methods by:

Computing relative stocks:

SELL

160

SELL

140

S tock price

SELL

120

100

i =1

80

The stock with highest R gets rank 1:

BUY

60

BUY

40

BUY

20

200

400

600

800

day number

1000

1200

25

Benchmarks

Performance measures

Theil coefficient:

y(t)=y(t-1)

predictions with the naive price predictions

R (t) = R(t - 1)

N

e.g AR-models (but also Neural Networks):

T=

y (t) = a i y(t - i)

i =1

( y(t) y (t) )

( y(t) - y(t - 1) )

27

Run the trading and compute the mean profit

{ t | R(t)R (t) 0, t = 1, N }

N

{ t | R(t)R(t

{ t | R(t)R(t

Mean profit =

- 1) > 0, t = 1, N }

- 1) 0, t = 1, N }

sign(

t =1

I.e:

A trade is assumed at every time step, in the

direction of the predicted change.

H

HN

28

Performance measures

H0 =

Performance measures

HN =

i =1

i =1

Buy at day 1 and sell at day N

H=

26

29

30

Evaluating performance

Evaluating performance

and down during one year of 250 trading days.

which is impossible to predict!

250

P (H = x ) =

x

shows about 54% hit rate.

Even 54% real hit rate is enough to make a fortune!

x=0.54*250=135 gives P(H>135)=0.092

comes up next, they just improve the odds by adding the 0

and 00

hit rate.

31

0 . 5 x 0 . 5 250 x

32

Evaluating performance

Evaluating performance

Sell and Buy signals on average once a week.

The test period is 10 years! We demand 55% hit rate!

Apply 100 totally random prediction algorithm on each week.

The probability that any one of them gets exactly x hits is:

P(H > x) = 1 P(H x) = 1 bincdf( x,500,0.5)

P(H>0.55*500)=0.0112

The probability that ANY of the 100 indicators produce 55%

hit rate is 1-minus the probability that all are less then 55%:

1 (1 0 . 0112 )100 = 0 . 68

Best: A final test on data that didn't exist at the time of the

development of the algorithm

It is sensitive to over training.

Be aware of the data-snooping problem!

Thomas Hellstrm 1997

33

Results so far

Future work

Used methods

34

Fuzzy rule bases

State space reconstruction and local models

k nearest neighbour techniques

Adaptive AR

Hundreds of technical indicators

Fundamental analysis much easier?

Problem: lack of huge amounts of data

Other methods

Results:

No statistically significant predictions

Significant seasonal patterns in data

35

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