10 Myths about Neural Networks

Neural networks have an indispensable relation to machine learning algorithms, and nobody
can deny their importance in algorithmic trading and time series forecasting when it comes to
quantitative finance. Credit risk modeling and stochastic are some other typical examples of the
uses of the neural network. However, temperamental performance is a cause of their bad
reputation which is an indeed the result of poor network design. It is necessary to remove
misconceptions about neural networks as it is the only way to towards reliable research on
neural networks. Let’s discuss a few of them.

1. Neural Networks Never Represent Human Brains

A human brain is a complex biological organ composed of many neurons. These neurons carry
information and responsible for transferring it to all the other parts of the body. Despite the
comprehensive research on the brain, scientists are still unable to understand the working of
mind correctly. They propose two theories about it, i.e., grandmother cell theory and
distributed representation theory. The former considers neuron a source of complex
information while latter asserts that neurons are simple objects which represent complex
information across many neurons.

It is the need to understand the actual difference between brain and neural networks as both
vary in sizes and organization. The mind is self-organized, and it does not require information
from any other source while neural networks are organized as per their architecture. In other
words, neural networks are not competitors of the human brain instead they are just a mimic of
the human intellect. The distinction is related to the difference between a bird’s nest and
Olympic stadium in Beijing. The structure of bird’s nest is the inspiration behind the architecture
of the stadium, and it represents a few features of the nest, but you can term it as a nest.
Moreover, neural networks have a close relation to curve fitting and regression analysis when it
comes to quantitative finance.
Conclusion: A neutron in the human brain is the highly sophisticated machine and
understanding its function is not easy. Unlike the biological neutron, the neuron in the neural
network is only a simple mathematical function and just an inspiration of human brain.

2. Neural Networks are not a Weak Form of Statistics

Interconnected nodes combine to form neural networks. A single layer is known as perceptrons
which are similar to multiple linear regressions. Both works as much linear regression generate
a signal and perceptrons feeds that signal and converts it into an activation function. The
produced function can or cannot be linear. The term multi-layered perceptrons represent the
layers of perceptions connected. There are three common types of these layers such as input
layer, hidden layer, and the output layer. The input layer is responsible for receiving input
patterns while the output layer contains a list of classification. Keeping the weighing balance on
the inputs least the error minimized on the neural network is the function of the hidden layer.

The simple neural network contains only one neuron which itself maps input and output. The

hidden layers receive data input from the production of another layer which works as
information for the next layer. It also extracts salient features from the input of the data that
works as predictive data for the output and the method is known as feature extraction.

The primary goal of a neural network is to minimize the measure of error. Sum-squared-error is
the most common error which can reduce with the optimization algorithm. Gradient descent
algorithm helps to calculate the partial derivatives of the mistakes which are weights layers in
actual. The goal of maximize performance can be achieved only by minimizing the errors.

Conclusion: Neural networks represent a stable abstraction of statistical techniques, and their
scope is not just limited to the weak form of statistics for lazy analysis.

3. Neural Network Have Multiple Architecture

Multi-layer perceptrons are the most uncomplicated architecture of the neural network. There
are lots of complicated structures which vary in weights, and the overall performance depends
on the masses and the functions. Optimization of the algorithm is not sufficient to increase the
production of the network, but you also need to consider the architecture as well. Following are
some examples of different architecture:

Recurrent Neural Network: These network all connection flow backward which indicates
the presence of the feedback hole in the system. They meant to financial markets and worked
well with time series data. Neural Turning Machine is the example of the recurrent neural
network which is a combination of memory and recurrent neural network.

Boltzmann Neural Network: Boltzmann Neural Network is also known as Boltzmann

machine. It was the first fully connected network which was intelligent enough to solve difficult
combination problems. These networks are not easy to train as they seem, but the user
observes remarkable efficiency once the networks get adequately trained. The downside of
Boltzmann neural network denies a connection between hidden neurons.

Deep neural networks: Image and voice recognition features distinguish this type of neural
networks. The famous examples of deep neural networks include convolutional neural network
and deep belief networks. The over fitting for financial marketers makes deep neural network
unsuitable for the finance industry.

Adaptive Neural Networks: It is the self-learning type of neural networks which is the
perfect match for financial needs. They are capable of optimizing and adapting their
architecture during the learning process.

Radial Basis Network: The activation functions of radial networks are radial basis functions
like Gaussian distribution. Due to their sophisticated form, these functions are perfect for
function interpolation.

Conclusion: There are hundreds of neural network architectures which vary performance and
sizes. To maximize their performance, you can combine and test several neural networks and
get a combined output.
4. Bigger Size Never Guarantees Higher Performance

The size of the architecture needs to consider, but it never guarantees performance. The
number of inputs, hidden layers, and hidden neurons is decisive performance factors, and they
determine the size of the network. Exact size is essential because too large and too small
systems cannot be well generalized.

Optimal Inputs: The problem you are going to solve decides the number of inputs while the
other factors include the quality and quantity of the data. Contributions have predictive powers
over the dependent variable, and there is a correlation between both of them. Linear
correlation metric and relatively uncorrelated variable are the two major problems while
choosing inputs with correlated parameters. In the first, you exclude the essential variables
while the second produces a robustly correlated variable. Principle component analysis is the
solution of optimal both problems.

Multicollinearity is another big problem in the selection of variables. It happens when two
independent variables highly correlated in the model. Regression model correctly answers to
this issue by making small changes in the values.

Ideal Number of Hidden Neurons: A large number of neurons trigger overeating, and it
causes the failure of statistical properties of data and learning the neural networks. Instead of
learning, it starts memorizing the patterns. Early stopping and regularization help to solve these
issues.

Output: There are two output methods used in neural networks. The first is the regression,
and the other is classification. You can set real numbers by mapping a single value in regression
method while an output neuron required in classification method for each possible class.

Conclusion: If you have two models, then follow the one with minimum parameters as it is the
best for generalization. This approach is called Ockham’s razor approach.
5. Training Algorithms are Available for Neural Networks

Back propagation is a famous and widely used algorithm which works on stochastic gradient
descent method. The algorithm helps to optimize the weights of the network. A sudden
condition can stop the working of algorithms such as network error and accuracy error. If you
check the functioning of back propagation algorithm, you will get to know it comprises two
steps. The feed forward pass passes data and generates the output after calculating the error.
Backward propagation passes error signal and uses gradient descent to optimize the network.

The slow performance of gradient algorithm generates problem by adjusting all weight at a time
causes insignificant movement of the masses which makes it susceptible to local minima.
Algorithms find it challenging to overcome local minima, and you can get help from Swarm
Optimization and Genetic Algorithm to solve the issue. Let’s check out how they are useful.

Neural Network Vector Representation: Use neural network as a vector of weight to

train the neural network for meta-heuristic search. Avoid its use for deep neural networks as
vectors get bigger in size and never fit well.

Practical Swarm Optimization: A swarm created for PSO neural networks for the training
purpose. The fitness function is used to calculate the sum-squared error of the reconstructed
neural network of the training dataset. The velocity of the weight as a vital role in the approach
as weights never takes much time in the adjustment which can result in no learning.

Genetic Algorithm: Three genetic operations applied to neural networks after constructing a
population vector. These operations are called selection, crossover, and mutation.

Conclusion: The combination of local and global algorithms always works well. It optimizes as
well as overcome the algorithms.

6. Immense Data is not essential for Neural Network

The neural network has three strategies, and they can use one of them as per their
convenience. Supervised learning strategy needs two data sets, one training set, and a testing
set. Training set has an input with expected output while the testing input does not require any
production. Labeled data is recommended for both strategies to clear the target. Hidden
structures which not marked can discover with unsupervised learning strategies. Their working
resembles the clustering algorithm. The responsibility of rewarding neural networks for good
behavior and punishing for bad behavior goes to reinforcement strategy, and they do not need
labeled data.

Unsupervised Learning: a Self-organizing map is the example of unsupervised neural

network architecture. This architecture helps uses multi-dimensional scaling technique to find
out the value and approximation of probability density function. You are allowed to use lower
dimensionally data sets for the best results. It is widely being used in stock trading due to the
coloring feature of SOM as the charts are used to demonstrate market conditions at a specific
time.

Reinforcement Learning: Policymaking function, the reward function, and value function
are the three main components of reinforcement strategy. The self-defining policy function is
used to set technical and fundamental features while reward function patches a difference
between good and evil performances. Value function the third component responsible for doing
long-term planning like the particular use of services to optimize the quantity of the
architecture.

Conclusion: Neural networks can efficiently work on small data if the user follows the proper
steps and functions.

7. Neural Networks Cannot Train on Any Data

Preprocessing of the data is essential before adding it to the neural network to get actual results
from it. There are various techniques used for the pre-processing of the data such as outlier
removal, data normalization, and elimination of redundant information. These techniques help
to improve the probability and performance of the data.
Data Normalization: Neural networks are the layers of perceptions which are connected.
Data normalization is used to remove redundant information, and neural network’s active range
scales the inputs differentiates the difference between these input patterns.

Outlier Removal: The smallest and the most significant values in a data set are known as the
outlier. These values can bring a substantial change in the data and affect the statistical
techniques. It happens because the performance of the model disturbs when the model tries to
adjust as per the needs of an outlier. The impact of the outlier on neural network is similar to
regression models. Don’t forget to remove outlier if you are working on training data set.

Remove Redundancy: If two variables in the neural networks are highly correlated, then
they can disturb the learning ability of the system. It depicts that the variable information is not
unique and it is a good practice to remove less significant information while the adaptive neural
networks are highly recommended to prune redundant connection. Faster training time is the
considerable benefit of redundancy.

8. Retrain Neural Networks for Better Results

Financial data keeps changing, and you cannot use the same data over again. Retraining of
neural information is necessary to get fresh and reliable results especially when it stops
working. The complex systems like financial systems which need to optimize often are called
non-stationary systems and neural networks are not recommended for such systems.

If you want to use the neural network for the financial industry, then retrain your data over time
or track the changes of the environment to adjust the architecture and weights. Multi-solution
meta-heuristic optimization algorithms are used to cater dynamic problems. Genetic algorithm
and multi-swarm algorithm are examples of these algorithms. The recent increases the memory
of the environment and latter is the derivative of swarm optimization.

Conclusion: Keep updating neural networks to get optimized results.

9. Don’t Disguise Neural Networks as Black Boxes

Neural networks are not black boxes, but itself works as the black box. They represent problems
which are needed to address. You can understand it with a simple example of the fund manager
who is unaware of the use of the neural network in trading decisions. The lack of knowledge will
never make him understand and access the possible risks of the use of the neural network in
trading. Rule-extraction algorithm is developed to solve this issue as it verifies various neural
network architectures. They work on the design and extract valuable data in the form of fuzzy
logic, mathematical expressions, and decision trees.

Mathematical Rules: The precise rules of neural networks are difficult to understand as the
extracted knowledge comes in linear regression form. That makes neural network unable to
solve black-box problems.

Propositional Logic: It works on a mathematical logic that is used to solve discrete

problems. It works like whether the value is TRUE or False. Logical operations are applied to get
the result. Alternatively, AND, and XOR is the conditional operation, and they are called
predicates.

Fuzzy Logics: It is the point where two logics meet, i.e., probability and propositional logics.
Membership functions of fuzzy logics determine the relation of a number with a specific domain
and the compound of fuzzy logic and neural networks result in Neuro-fuzzy systems.

Decision Trees: They demonstrate the process of decision making while the term decision
tree induction refers the method of extraction of decisions from neural networks.

10. The Implementation of Neural Networks is Effortless

The availability of open source codes has implemented neural networks effortlessly. Here are
some packages of neural networks useful for quantitative finance.

CAFFE: It is a broad learning framework developed by Berkeley Vision and Learning Center.
The package made of expressions and modularity in mind.
Webpage - http://caffe.berkeleyvision.org/

GitHub Repository - https://github.com/BVLC/caffe

ENCOG: The machine learning framework supports advanced algorithms. It is efficient is data
normalization and works well for machine learning algorithms like Vector Machines, Genetic
Programming, and Artificial Neural Network. It works well with multi-core hardware like Encog
training algorithm.

Webpage - http://www.heatonresearch.com/encog/

GitHub Repositories - https://github.com/encog

H2O: It a smart and reliable machine learning API and not a package indeed. Deep learning
model and generalized linear model are easy to learn with the help of the API support.

Webpage - http://h2o.ai/

GitHub Repositories - https://github.com/h2oai

Google TensorFlow: It is an open source library allows the use of data flow graph for
numerical computation. Node and edges are used to represent the data while the flexible
architecture is highly useful for newbie.

Webpage - http://www.tensorflow.org/

GitHub repository - https://github.com/tensorflow/tensorflow

Microsoft Distributed Toolkit:

DMTK frameworks include various projects like Distributed word embedding, Multiverso, and
distributed skip-gram mixture.

Webpage - http://www.dmtk.io/

GitHub repository - https://github.com/Microsoft/DMTK

Microsoft Azure Machine Learning: It is an entirely managed cloud service which is
highly compatible to build and deploy analytical solutions. The entire work has become
effortless due to the availability of drag and drops feature and custom-built components.

Webpage - https://azure.microsoft.com/en-us/services/machine-learning

GitHub Repositories - https://github.com/Azure?utf8=%E2%9C%93&query=MachineLearning