Impact of Financial Ratios and Technical Analysis on
Stock Price Prediction Using Random Forests
Loke K.S.
Faculty of Engineering, Computing and Science.
Swinburne University of Technology Sarawak Campus
Sarawak, Malaysia
ksloke@swinburne.edu.my
Abstract— A stock movement prediction method is presented
using quarterly financial ratio data from Hong Kong companies
from the period, 2011-2014. We found that the accuracy of price
movement prediction using Random Forest method over multiple
quarters to be fairly weak. However we were able to predict with
high accuracy in the last quarter of 2014 and not in other years.
We attribute this not to the superiority of the method but to the
non-stationary nature of the price signals.
Keywords— Stock Prediction, Stock market, Random Forest,
Financial Ratios
I. INTRODUCTION
The use of artificial intelligence and machine learning
techniques to determine future trends of the stock market is an
active research area. Even though the Efficient Market
Hypothesis [1] posits that all relevant information are already
reflected in the prices and impossible to outperform the market,
this thesis has its critics. Some studies show that at very short
time span, price movements can be predicted better than
chance [2] . Others have found that news can effect price
movements as well [3] [4] [5]. In this research we studied the
effect of financial ratios on market price prediction using
random forests methods which is a well-known method in
machine learning introduced by Breiman [6].
This paper is organized as follows. In section 2, we will
review some of the previous related works that used machine
learning methods. We describe the Random Forest algorithm in
section 3. Next in section 4, we will present our approach and
methods. The experimental results are presented in section 5.
Finally, the conclusion of our work is summarized in the last
section.
II. LITERATURE REVIEW
There have been many empirical researches on the
predictive power of financial ratios and many of the results are
mixed. In his review, Hjalmarsson [7] has found that using
dividend- and earnings-price ratios as regressors were sensitive
to sample period and choice of frequency. His own research
showed that traditional valuation methods such as dividend-
and earnings-price had very limited predictive power. Fama
and French [8] have found weak evidence on dividend yield
predictability on monthly (New York Stock Exchange) NYSE
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returns. Lewellen [9] also found that dividend yield predicts
market returns. However, Goyal and Welch [10] argues that the
evidence was too weak. Lau et al [11] found earnings- price
ratio relationship to market returns to be conditional. Many of
these studies (as above) used statistical analysis, regression and
ordinary least squares to find the relationship between price
and the financial ratios. The application of artificial intelligence
and machine learning was not widespread.
However in the field of technical analysis the use of
machine learning methods were quite common. The use of
evolutionary methods such as Genetic Algorithms [12], Swarm
Optimization [13] and Evolutionary Learning [14] is also
popular. Patel et al compared the use of Artificial Neural
Networks, Support Vector Machines, Random Forests and
Naïve Bayes on prediction stock movement direction [15].
Their data indicated good results with Random Forests.
Similarly, Ballings et al [16] also compared a variety of
ensemble algorithms against single classifiers models including
Support Vector Machines, Neural Networks and Logistic
Regression. They also concluded that Random Forest ensemble
method should be used for stock price direction prediction.
Ladyzynski et al [17] also used Random Forest for stock price
trend detection. Eventhough they failed to generate a profitable
trading strategy, they concluded that the artificial intelligence
approach is promising. Ash et al [18] used a recency-weighted
Random Forest to take into consideration seasonality which
they claimed superior results. Given that a number of recent
works have been optimistic on ensemble methods like Random
Forest, we decided to adopt Random Forest in our tests.
III. RANDOM FOREST
Random Forest is an ensemble classification algorithm that
uses a collection of decision tree in combination. Random
Forest was first introduced by Leo Breiman [6] following on
the ideas of Amit et al [19] and Ho [20]. The method requires
the random selection of features (or attributes) to split at each
of the decision tree node. The random factor makes the
individual trees uncorrelated. This makes the Random Forest
robust to noise and resistant to over training. Each of the trees,
at the end of the tree traversal, will cast a vote for the
classification of the input class; the sum of the total vote that
constitutes the majority will be the classification. A single
random tree classifier will only have a slightly better than
random classification but combining them as an ensemble can
produce very much improved accuracy. A feature of Random
Forest is that it does not overfit but will reach a limiting value
of generalization error.
IV. APPROACH
We used a dataset that consists of 433 companies listed in
the Hong Kong Stock Exchange from 2011-2014. We calculate
for each of the companies a set of 63 attributes in which the
majority of them were related to financial ratios per quarter.
For each quarter, the returns in the next quarter were also
calculated based on historical data. For example, if the
financial data was for quarter 1 (Q1), then the returns column
would have the difference in price from the start till the end of
the next quarter, i.e. Q2. However, not all the financial ratios
were available for all companies, therefore some values were
missing. The data format per quarter is as follows: [Company-
id, ratio1, ratio2, ratio3, …, ratio62, next-quarter-returns]. So
for Q1 data, the returns value is actually the next quarter
returns, i.e. Q2. All data have been normalized to have zero
mean and variance of 1.
Some of financial ratios included are: Liquidation
value/Market Cap, Book Asset Value/Market Cap,
Sales/Market Cap, EBITDA/Enterprise Value,
Earnings/Market Cap, Operating Cash Flow/Market Cap,
Dividend/Market Cap, Return on Assets, Return on equity,
Return on invested capital, Net Asset Value/Total Assets,
Revenue growth first half, Earnings per share first half, Net
Assets Growth Rate over 5 years, Return on Asset Margin over
5 years, Book to Price previous 5 years average deviation,
market capitalization and Dividend Yield ratio previous 5 years
average deviation. The rest are variations of the above
calculated with slightly different periods and transformations.
We investigated if the calculated financial ratios have any
impact on future price direction. Instead of using actual return
values, we set the values to be 1 or 0, depending on whether it
is above a threshold (e.g. threshold=0) or below it.
A. Experiments
We performed the following experiments.
1) Experiment A.Used all attributes (columns) but vary NA
values, quarter, year and threshold
a) Combined all Q4 as rows from 2011-2014 by using
all columns to create a model to classify returns direction with
threshold set to 0. We only used Q4 instead of Q1 through Q4
because the data may be seasonal [21]. The table rows were
partitioned into 10-fold validation.
b) Model each quarter (Q1,Q2,Q3,Q4) in 2013 and
2014 to classify return direction separately.
2) Experiment B. Varied the attributes (columns) and
predicted the returns in the Q3 and Q4 dataset. All those with
incomplete data (with NA) were removed.
a) Used Q1 2014 data
b) Used Q1 2013 data
3) Experiment C. Varied the attributes (columns), trained
with Q3 data and predict the returns in the Q4 dataset. This is
called a one quarter walk forward test.
a) Used combined 2013-2014 data
b) Used combined 2011-2012 data
Experiments A and B made use of the next-quarter-returns
in creating the model. However that makes it not useful for
actual prediction because the next-quarter-returns were
required to create the model.
Experiment C removed that requirement by training on Q2-
Q4 returns and predicting Q5 return direction using Q3-Q4
values, that is, we treat it as a single quarter moving time
series. We created a model using all Q1 attributes, Q2-returns
and Q3-returns to classify Q4-returns. This model was then
used to classify Q5-return direction. All Q5 values have not
been used in the training set.
In all the experiments we used Weka to perform the
training and classification. In some cases we also performed
the same experiment using Rattle/R [22]. We used the Random
Forest [6] classifier in Rattle/R to obtain the important
attributes. We exclusively used the Random Forest classifier in
Weka [23], varying the number of trees and random attributes
to choose from. We typically use 100-400 trees and with 10-
fold validation unless mentioned otherwise. Some of the
attributes might not be independent since the random forest
algorithm would only randomly selects ome of attributes for
each tree.Varying the number of trees and attributes only
resulted in marginal changes.
V. EXPERIMENTAL RESULTS
Experiment A(a) used combined quarters of Q4 from 2011
to 2014 with the companies that had incomplete information
removed. The classes were balanced by removing some classes
manually so that class distribution was less skewed (0=195,
1=173). We also tested classes that were resampled using the
Weka Class balancer to create an equal class distribution
(0=240,1=240). Same quarters were used because there might
be seasonal patterns. The classifier was to return Q4-returns
(which are the next quarter returns) direction. The results are
shown in Table 1.
TABLE I. 2011-2014 Q4 RETURNS DIRECTION CLASSIFICATION

c) As in b) above but used different threshold. Balancing Trees Accuracy % Kappa AUC
Manual 100 65.22 0.2931 -
d) As in b) above but used different NA values. We Manual 200 66:03 0.3081 -
wanted to test what NA values should be used. Manual 400 66.30 0.3147 0.699
Weka 400 62.90 0.2596 0.709

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 There were only marginal differences in using different TABLE II. 2013-2014 PER QUARTER RETURNS CLASSIFICATION
number of trees. Secondly reporting accuracy (the percentage QYYYY Threshold NA Accuracy AUC
of correctly classified instances) was misleading because of 12013 0.2 99 70.43 0.755
skewed class distribution, so would be reported as Area under 22013 0.2 99 70.2 0.659
the Curve (AUC) values instead [24]. A value of AUC=0.5 or 32013 0.2 99 67.9 0.712
less was random and a value of 1.0 was perfect classification. 42013 0.2 99 65.5 0.652
A good value of AUC should be around 0.8 and above. 12014 0 0 67.2 0.651
12014 0.2 0 83.4 0.616
A(b)-(c). The per quarter results are presented in Table II. 22014 0.2 0 61.4 0.633
The number of trees was 400. The number of companies is 433 42014 0 0 67.9 0.718
in each quarter. The input attributes were the entire financial 42014 0.2 0 66.1 0.718
ratios to classify the next quarter return direction. The accuracy
% precentage should not be used for comparison because of
skewed class distribution.

Fig. 1. Hang Seng Index Jan 2011- Jan 2015 with SMA and EMA overlays

TABLE III. 2014 Q3 AND Q4 RETURNS DIRECTION PREDICTION WITH DIFFERENT ATTRIBUTES
All Return Return.2 Return.3 RET.2 RET.3 R3 Class AUC
D D D D D D D R4 0.853
D D D R4 0.739
D D R4 0.645
D D D D R4 0.889
D D D R3 0.741
D D D R3 0.819
D D D D D D R4 0.867
D D D R4 0.849
D D D R4 0.864

TABLE IV. 2013 Q3 AND Q4 RETURNS DIRECTION PREDICTION WITH DIFFERENT ATTRIBUTES
All Return Return.2 Return.3 RET.2 RET.3 R3 Class AUC
D D D D D D D R4 0.937
D D D D D D R4 0.972
D D D R4 0.847
D R4 0.724
D D R4 0.761
Table III shows the results of 2014 quarters using different The values indicated that R4 values (direction) were fairly
attributes. Return.2 refers to the third quarter returns. RET.2 predictive without the financial ratios, in other words, it was
refers to the cumulative value by adding Return and Return.2; predictive based on prices alone. Given various financial ratios
similarly for RET.3. R3 were set to 1 if the RET.3 were above calculated over every quarter and the returns for subsequent
one, and zero otherwise. Table IV shows similar results for quarter, the 4th quarter was quite predictable. In fact, it was
2013. predictable without the financial ratios. However, this form of
classification used R4 information in generating the model.

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 We have found that prices were informative in predicting
price directions. In Table V, the results of using quarter returns
as a time series prediction with one quarter lag were presented.
The table also shows which attributes were used. We trained
the model using up to Q3 data and used it to classify Q4 data.
TABLE V. USING Q3 LAGGED VALUES TO PREDICT PRICE
DIRECTION AT Q4 FOR 2011 AND 2014
QYYYY All Return,Return Accuracy Kappa AUC
.2,RET.2,R3
12014 D D 88.98 0.7761 0.920
12014 D 88.04 0.6936 0.880
12011 D D 38.85 -0.1238 0.414
12011 D 34.20 -0.138 0.396
There seemed to be an anomaly here. The data was
predictive for 2014 but not for 2011. We would discuss this
further in the conclusion section.
VI. DISCUSSION
The results reported in Table I and II showed just slightly
better than random results. This indicated that using financial
ratios to predict the next quarter results was not reliable. This
was despite the fact that the next quarter return values were
used in creating the model. We did not test further the impact
of using different threshold or NA values since the prediction
results were not good, increasing slight accuracy was not
meaningful.
Tables III and IV showed the results for longer term impact
beyond the one quarter returns. They tested for 1 year (4
quarters) cumulative return direction (R3) and for 5 quarters
return direction (R4). The results were more positive here,
seemingly there was a correlation between the inputs to the
predicted class. It seemed there was a close relationship
between the quarterly returns to R3 and R4, again indicating
that the financial ratios did not play a big role. On closer
examination, R3 and R4 were also highly correlated.
However, the same results were not obtained when using
2011 data, as shown in Table V. The results in Table V were
obtained using a model trained up to R3 but tested on R4,
unlike in previous results. Good results were obtained for 2014.
For the year 2011, the model trained up to R3 could not predict
values for R4 that it had not seen.
This can be cleared up by examining the overall Hong
Kong Hang Seng index for those relevant years. Fig. 1 shows
the period from January 2011 to January 2015 with Simple
Moving Average (SMA-50) and Exponential Moving Average
(EMA-50), both with a period of 50 days. The difference
between the two periods 2011 and 2014 can be seen clearly.
The period from 2011 to early 2012 showed an early rise and
drop whereas in 2014, it was a steady rise until early 2015.
This would explain why the model for 2014 could be predictive
for 1Q 2015 (R4) and not for 2012 because the prices in 2011-
2012 were fluctuating. The simple model was not powerful
enough to take into consideration all the cause of the
fluctuation.
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These results also explained why some research reported
highly predictive values; that was by selecting the appropriate
time period for their experiments to obtain high prediction
scores.
The results implied that the correct predictive model may
need to be episodic (essentially non-stationary), that is the
model is only useful within a period of time and may be
required to be updated when there is a change in the operating
environment. Many researches have shown that stock prices
are non-stationary [17]. This suggests a research direction to
identify what are the triggers for the change in the environment
(also called regime change) that will prompt model relearning.
Some of these triggers will be an external event in the macro
environment, and will be conveyed through news events or
social media. It can also be conveyed through the early price
movements. Many of the researches use these signals directly
for prediction; we believe that it will be useful to study them as
triggers for model re-learning.
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