CHAPTER -1

INTRODUCTION

1.1 INTRODUCTION

The prediction of stock market movement has been an issue of interest for centuries.
Notwithstanding years of study and the newest technology, it seems that no technique has been
exposed that constantly works. Essential analysis frequently works best over longer periods of
time, where technical analysis is more appropriate for short term trading. Neural networks
present the capability to process large amounts of data quickly and retain information learned
from that data to be used again in the future. Technical analysis presents a little extra concrete
method of evaluation at the cost of locating and implementing the algorithms themselves.

With the development of China’s financial system, the stock market, as well as investment
analyses, is also growing, becoming an essential part of the securities industry, even the whole
financial industry, and gaining increasing attention from investors. The analysis and prediction of
data in stock transaction, is of great theoretical significance and practical value in guiding the
rational investment, reducing the risk for investors, regulating the order of China’s securities
market. In China, research on the financial forecast focuses on a few areas: securities investment
analysis, time series analysis, regression analysis, the gray series analysis, forecasting of
portfolio and black-box model for prediction. Black-box model prediction research focuses in
recent years. Models commonly used include neural networks, genetic algorithms, and fuzzy
systems so on. But the black-box model has some shortcomings; not to have the knowledge,
theory results for the degree of confidence cannot be evaluated, which significantly limits the
application of prediction; for the noise data cannot be effectively ruled out, resulting in
inaccurate prediction model. In this paper, a modified black box model, to solve the above
problems, and obtained good empirical results [1].

The prediction of stock market movement has been an area of interest for centuries. After so
many years of study and the latest technology, it seems that no method has been discovered that
works consistently. Earlier attempts at solving this problem have employed a wide of array tools
and strategies. Among those, several utilized some type of neural network in an attempt to learn
1
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from historical data and apply those findings to predict current data [2, 3]. Other approaches use
technical analysis to locate patterns in data that suggest certain movement trends [4]. These
patterns in the data are constructed by conforming to a series of rules based on the stock price
and volume of trading over a series of days. Technical analysis is based on the assumption that
previous market data reflects all of the relevant information about a stock and therefore
predictions can be made from this. Still another method, known as fundamental analysis, looks at
competitors, business' financial statements and business strategies in addition to evaluating
historical data in an effort to make a prediction.

The goal of fundamental analysis is to determine the value of a stock based on the previously
mentioned factors and to act on the assumption that the actual stock price will eventually reflect
the determined value. As a result, fundamental analysis usually works best over long term
trading, whereas technical analysis is much suitable for short term trading [5]. Neural networks
offer the ability to process large amounts of data quickly and retain information learned from that
data to be used again in the future. To some extent Technical analysis provides a more concrete
method of evaluation at the cost of locating and implementing the algorithms yourself.
Fundamental analysis seems optimal as it utilizes the largest information set and has many well
known practitioners such as Warren Buffett and Peter Lynch, but is more difficult to implement
via an Artificial Intelligence system mainly because such information is not often available
publicly. Moreover, assessment techniques for fundamental analysis are far more complicated
and difficult to automate. Lastly, gains realized by fundamental analysis usually take years to
mature fully [5], so comparative research studies would not be feasible.

1.2 STOCK MARKET PREDICTION METHODS

Stock market prediction is the act of trying to determine the future value of a company stock or
other financial instrument traded on a financial exchange. The correct prediction of a stock's
future price could yield significant profit. Many believe that stock price movements are governed
by the random walk hypothesis and thus are unpredictable. Some disagree and those with this
viewpoint have a myriad of methods and technologies which purportedly allow them to gain
future price information. There are three categories of stock market prediction methods which
have used by the researcher till now.
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1.2.1 FUNDAMENTAL ANALYSIS BASED STOCK PREDICTION

Introduction to Fundamental Analysis

Fundamental analysis of a business analyzes its financial statements, its management and
competitive advantages, and its competitors and markets. It considers on the overall state of the
economy, and focuses on factors including interest rates, production, earnings, employment,
manufacturing and management. When analyze a stock, futures contract, or currency with the
help of fundamental analysis, one can use either bottom up analysis or top down analysis.
Fundamental analysis is implemented on historical and present data with the goal of making
financial prediction.

The fundamental analysis involves the in-depth analysis of a company’s performance and the
profitability to measures it’s intrinsic value by studying the company physically in terms of its
product sales, man power quality, infrastructure, profitability on investment. This analysis uses
revenues, future growth, return on equity, profit margins, and other data to calculate a company's
underlying value and potential for future growth.

To a fundamentalist, the market price of a stock tends to move towards its “real value” or
“intrinsic value”. If this value of a stock is above the current market price, the investor can take
the decision to purchase the stock because the stock price will bound to rise and move towards
its “intrinsic value”. If this intrinsic value of a stock is led than market price, the investor may
decide to sell the stock because the stock price is bound to fall and come closer to its intrinsic
value. To start finding out the intrinsic value, the analyzer makes an examination of the current
and future overall health of the economy as a whole.

Assumptions of Fundamental Analysis

a. Stock price (current and future) depends on its intrinsic value and can anticipate
return on investment.

b. Investors are 90% logical, examining their investments in detail.

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1.2.2 TECHNICAL ANALYSIS BASED STOCK PREDICTION

Introduction to Technical Analysis

Technical analysis is a method of evaluating stocks by analyzing statistics generated by market

activity, past prices, and volume. It looks for trends, patterns, peaks, bottoms and many other
factors affecting a stock's price movement. Future values of stock prices often depend on their
past values and the past values of other correlated variables. Technical analysis looks for
patterns and indicators on stock charts that will determine a stocks future performance.

However, it is used by approximately 90% of the major stock traders. Regardless of its
widespread use, this analysis is criticized as it is highly subjective. Individuals can interpret
charts in their own manner.

Recently, neural networks have been successfully applied in time-series problems to improve
multivariate prediction ability. Neural networks have good generalization capabilities by
mapping input values and output values of given patterns. Neural networks are usually robust
against noisy or missing data and all of them are highly desirable properties in time series
prediction problems. Many neural network models have already been developed for the stock
market analysis.

Assumptions of Technical Analysis

a. Market moves in trends dictated by the constantly changing attitudes of investors in response
to different forces. History repeats itself i.e. under similar types of inputs the stock behave in
similar way.

b. Prices have tendency to go with the trend rather than against it. Investors are 90%
psychological. They react to changes in the market environment in predictable ways.

1.2.3 TECHNOLOGIICAL ANALYSIS BASED STOCK PREDICTION

With the arrival of the digital computer, stock market prediction has moved into the
technological realm. The most well-known technique involves the use of Genetic Algorithms and
Artificial Neural Network. ANNs can be defined as mathematical function approximations. The
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common form of ANN in use for stock market prediction is the feed forward network utilizing
the backward propagation of errors algorithm to update the network weights. They are
commonly referred to as Back propagation networks. Another form of ANN that is more
appropriate for stock prediction is the time recurrent neural network (RNN) or time delay neural
network (TDNN). Examples of RNNN and TDNN are the Elman, Jordan, and Elman-Jordan
networks. The applications of technological analysis are spread together with the development of
knowledge in the branch of mathematical analyses. The aim is to fix best the future development
of prices of shares and commodities during the operation in the world market. Several methods
have been used for forecasting stock price such as traditional, fundamental and technological
methods. But these previous methods have limits and not completely capable to provide
accuracy. Data mining and computational intelligence techniques for resolving the problems of
stock price forecasting have become rapidly growing alternative methods for achieving
significant degree of accuracy.

1.4 PROBLEM DEFINITION

Stock market price index prediction is a challenging task because the stock market values keeps
on changing day by day. Researchers have made many attempts to predict the performance of
financial market. Existing prediction model ranges from traditional approaches to artificial
intelligence techniques such as fuzzy systems and artificial neural networks. However the main
drawback of ANNs and black box techniques is tremendous difficulty in interpreting their
results. The technique implemented for the stock market prediction using the combinatorial
method of genetic and fuzzy system is developed having very close prediction of stock market
values .But the predicted values are not very accurate and error rate is more. So an efficient
technique is implemented for the prediction of stock market values using K-means and
horizontal partitioning algorithm.

1.3 MOTIVATION

Data Mining is the process of extracting implicit, previously unknown and potentially useful
information from data. Data mining is always used in techniques for finding and describing
structural patterns in data as a tool for helping that data and make prediction. Traditional
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techniques for data mining require multiple scans of data to extract the information that is
infeasible for stream data. It is impossible to store an entire data stream or to scan through it
multiple times due to its great volume. The amount of events in data streams which had
previously happened is usually extremely large. The difficulty with technical analysis is that a
complete pattern is required to make an accurate prediction on the stock movement. Preferably,
such a forecast should be made before the pattern was completed to facilitate prediction. For this
task execute a Time-Delay Artificial Neural Network known as Midas. Similar to Metis, Midas
receives input data including close, open, low and high prices per day for a particular stock ticker
over a period of time, along with the equivalent trading quantity for every day. This data is
adequate for employing technical analysis through Metis and is therefore used as the input data
for Midas as well [11].

1.5 OBJECTIVES

This work has following objectives:

1. To implement efficient prediction system for stock market prediction.

2. To reduce time complexity and space complexity.
3. To provide efficient stock market prediction system using K-mean clustering.
4. To reduce error rate and improve prediction capability using decision tree.
5. To implement efficient system for prediction system using K-mean clustering and
decision tree.

1.6 DISSERTATION ORGANIZATION

The layout of remaining dissertation is as follows:

Chapter 2 Literature Survey describes the related techniques and Literature review along with
various schemes proposed by various researchers.

Chapter 3 Application of Data Mining Techniques in Stock Market Prediction focuses on

data mining techniques used for stock prediction. It also describes clustering and decision tree
algorithms.
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Chapter 4 K-Means & Horizontal Partition Decision Tree based Methodology, this chapter
deals with the description of K-Means and Horizontal Partition Decision Tree methodology.

Chapter 5 Simulation & Result Analysis states various assumptions taken, data & algorithms
used to develop the application and also provide a view of working environment in which
application will run. Chapter also describes the implementation and gives analysis of result.

Chapter 6 Conclusion and Future Work states conclusion of the work with the possible future
application and enhancement of the system.