Page 201 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes chaos theory may eventually provide some potential answers. If the apparent randomness
of security price changes, can be shown to be non-random, much of the theory of finance
would need revision.

Self Assessment

Fill in the blanks:
6. ………………..................... numbers have intrigued mathematicians and scientists for
hundred of years.

7. Nikolay Kondratev was a ………………..................... economist and statistician born in 1892.

10.4 Neutral Networks

A neutral network is a trading system in which a forecasting model is trained to find desired
output from past trading data. By repeatedly cycling through the data, the neutral network
eventually learns the pattern that produces the desired output. If the desired output remains
elusive, more data is included until a pattern is found. Neutral networks may also include a
feedback mechanism whereby experience gained from past errors.
 This topic is a hot one in the investment community. National conferences have been
organized dealing exclusively with this topic, and the trade literature publishes many
articles upon this. A problem with concept of a neutral network is that the stock market is
seldom deterministic. Situations constantly change, and what may have been true a few
years ago will not necessarily prevail tomorrow. Financial academics are especially leery
of back-tests, or research that tests a hypotheses using past data. Mining the data will
almost always result in some apparent cause and effect between past events and stock
market performance. Research that tests a hypothesis using subsequent data is much more
useful. An article in the popular press describes Wall Street’s response to this criticism.
 One way to get around this hazard is to build something called a genetic algorithm into
your neutral network. A sexy term that currently causes Wall Street rocket scientists to
swoon, genetic algorithms enable neutral nets to adapt to the future buy spawning schools
of baby nets, each of which is sent to swim against the changing flow of data, where only
the fittest survive to take over the role of the mother.

 No matter what someone’s field of study, they are interested in the search for a better
mousetrap. Essentially, what all security analysts seek to do is to find improvements in
their methodology for security selection.

10.5 Tools of Technical Analysis

The technician must (1) identify the trend, (2) recognize when one trend comes to an end and
prices set off in the opposite direction. His central problem is to distinguish between reversals
within a trend and real changes in the trend itself. This problem of sorting out price changes is
critical, since prices do not change in a smooth, uninterrupted fashion.
The two variables concerning groups of stocks or individual stocks are:
1. Behaviour of prices, and
2. Volume of trading contributing to and influenced by changing prices.

The use of technical ‘indicators’ to measure the direction of overall market should precede any
technical analysis of individual stocks, because of systematic influence of the general market on
stock prices. In addition, some technicians feel that forecasting aggregates a more reliable, since
individual errors can be filtered out.

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