Forecasting ETFs with Machine Learning Algorithms

Posted: 17 Jan 2017 Last revised: 16 Sep 2018

See all articles by Jim Kyung-Soo Liew

Jim Kyung-Soo Liew

Johns Hopkins University - Carey Business School

Boris Mayster

Johns Hopkins University - Carey Business School (JHU), Students

Date Written: January 14, 2017

Abstract

In this work, we apply cutting edge machine learning algorithms to one of the oldest challenges in finance: Predicting returns. For the sake of simplicity, we focus on predicting the direction (e.g. either up or down) of several liquid ETFs and do not attempt to predict the magnitude of price changes. The ETFs we use serve as asset class proxies. We employ approximately five years of historical daily data obtained through Yahoo Finance from January 2011 to January 2016. Utilizing our supervised learning classification algorithms, readily available from Python’s Scikit-Learn, we employ three powerful techniques:

(1) Deep Neural Networks,

(2) Random Forests, and

(3) Support Vector Machines (linear and radial basis function).

We document the performance of our three algorithms across our four information sets. We segment our information sets into

(A) past returns,

(B) past volume,

(C) dummies for days/months, and a combination of all three.

We introduce our “gain criterion” to aid in our comparison of classifiers’ performance. First, we find that these algorithms work well over the one-month to three-month horizons. Short-horizon predictability, over days, is extremely difficult, thus our results support the short-term random walk hypothesis. Second, we document the importance of cross-sectional and intertemporal volume as a powerful information set. Third, we show that many features are needed for predictability as each feature provides very small contributions. We conclude, therefore, that ETFs can be predicted with machine learning algorithms but practitioners should incorporate prior knowledge of markets and intuition on asset class behavior.

Keywords: Machine Learning, ETFs, Forecasting and Predicting Returns

Suggested Citation

Liew, Jim Kyung-Soo and Mayster, Boris, Forecasting ETFs with Machine Learning Algorithms (January 14, 2017). Available at SSRN: https://ssrn.com/abstract=2899520 or http://dx.doi.org/10.2139/ssrn.2899520

Jim Kyung-Soo Liew (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

Boris Mayster

Johns Hopkins University - Carey Business School (JHU), Students ( email )

United States

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