Machine learning and short positions in stock trading strategies

David E. Allen*, Robert J. Powell, Abhay K. Singh

*Corresponding author for this work

Research output: Chapter in Book/Report/Conference proceedingChapter

1 Citation (Scopus)

Abstract

Any investment strategy requires some form of asset evaluation, that is, determination of the price or fundamental value, and the prediction of likely future price movements using financial, technical, or fundamental indicators. The decision to adopt a long or short position in an asset requires a view on its immediate future price movements. Financial forecasting involves a huge data processing exercise, which may be noisy, nonstationary, and unstructured in nature, for which customary statistical methods, such as linear logistic regression and discriminant analysis are frequently applied. The development of more flexible methods, such as support vector machine classification, offers practitioners potentially better and more powerful solutions. This chapter applies support vector machines (SVM) to predict the direction of price changes for a small set of Dow Jones Industrial Average stocks and tests them against the predictions obtained from logistic regression analysis. SVM is a machine learning algorithm, which is characterized by its particular decision functions and ability to apply linear and non-linear transformations using different kernel functions. The results show that SVM improves on simple logistic regression and provides more accuracy in predicting price changes. As SVM is established on structural risk minimization, it is more resistive to overfitting than other learning methods used for empirical risk minimization and may perform better. It also performs well in comparison to other commonly used forecasting methods such as ARIMA and Artificial Neural Networks.

Original languageEnglish
Title of host publicationHandbook of short selling
EditorsGreg N. Gregoriou
Place of PublicationWaltham
PublisherElsevier
Chapter32
Pages467-478
Number of pages12
Edition1st
ISBN (Electronic)9780123877253
ISBN (Print)9780123877246
DOIs
Publication statusPublished - 2012
Externally publishedYes

Keywords

  • book-to-market ratio
  • dividend yield
  • hyperplane
  • investment returns
  • logistic regression
  • price-to-earnings ratio
  • radial basis function
  • Sharpe ratios
  • support vector machines
  • traded volume factor

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