Short term stock market forecasting tool

McGill University researchers have developed a software program to make day to

day predictions of stock price variations. The prediction algorithm is based on a
new hypothesis about the predictability of stock prices: the “Live Market
Hypothesis”. McGill University is looking for users to further test and validate the
prediction model, and for partners to commercialize the software.

Historically, work in the area of stock market prediction has been divided into four
categories: technical analysis, fundamental analysis, time series forecasting, and
machine learning methods. However, despite the tremendous amount of research
efforts in the area of stock market prediction only limited success has been
obtained to this point, leading many to doubt the feasibility of stock market
prediction. Market behaviorists propose that it is not possible to consistently
outperform the market through decisions based on past historical data, since
stock prices already convey all publicly known information and reflect the true
underlying value of the stock the company represents. According to this view,
short term stock prices variations follow a random walk, and such variations are
essentially noise that cannot possibly be predicted.

McGill researchers rather see the market as a complex, but organized and
coherent system. In this global market, millions of various entities make decisions
that affect future outcomes. More specifically, McGill researchers postulate that
the changes in stock prices, both in the long and in the short term, are indirectly
caused by the actions taken by market entities. That is, the entities that are part of
the market govern the future of the market. Furthermore, because of the inherent
interactions between market entities (companies competing, cooperating, buying
each other, etc.), there exist connections, or correlations between the prices of
different stocks at different time points, that reflect the constantly changing
connections between market entities. McGill researchers call this the Live Market
Hypothesis. According to this hypothesis, the market, in the short term, is not
fundamentally unpredictable, and stock prices do not follow a random walk.
Instead, McGill researchers propose that short term predictions can be made, by
analyzing the existing relationships between market entities.

Applications

Short term stock market forecasting

 Technology
McGill researchers have designed an algorithm to test the validity of the Live
Market Hypothesis, called the Temporal Correlation Estimator (TCE). This
algorithm estimates the temporal covariance between stock price variations, and
use this data to make short term predictions. A simulated trading environment has
been designed in order to assess the potential of the TCE. This environment is
designed to realistically represent a real trading environment and its constraints, so
as to establish whether a trading strategy based on a given predictive algorithm
has potential for yielding profit in the real world. For each active trading day within
the input range, it then queries the input algorithm to know which stocks, among
the list of market entities given as input, are expected to rise in value from the
current day to the next.

The TCE was compared with three other trading strategies applied on four lists of
stocks in the NASDAQ-100; the S&P 500 the Dow Jones market indices, and a
custom list of 68 companies, as of July 4, 2007. The other trading strategies were :
1) looking at the derivative of a least-squares quadratic fitting of the stock prices
over the last days, 2) looking if the current value of a stock is below its average
value over the last days; and 3) looking if the stock value has been rising over the
last days. Simulation results show that, when taking into account real-life
constraints, such as transaction costs, slippage and taxes, the TCE turns out to be
the best performing strategy, leading to significant gains as compared to the three
other approaches.

The Inventors
Dr. Doina Precup joined the School of Computer Science at McGill University in
July 2000, as a tenure-track assistant professor. Doina Precup's research interests
lie mainly in the field of machine learning. She is especially interested in the
learning problems that face a decision-maker interacting with a complex, uncertain
environment. She uses the framework of reinforcement learning to tackle such
problems. Her current research is focused on developing better knowledge
representation methods for reinforcement learning agents. She is also more
broadly interested in reasoning under uncertainty, and in the applications of
machine learning techniques to real-world problems.

Maxime Chevalier-Boisvert was a graduate student at McGill University with

interests in the fields of compilers, 3D graphics, artificial intelligence and simulation

Françoys Labonté, Ph.D., Eng.

Office of Technology Transfer
514-398-5786
francoys.labonte@mcgill.ca
Reference code: 09012
Opportunity: End-user license, exclusive or non-
exclusive commercialization licenses