Introduction
The stock market is a dynamic and complex financial system influenced by various factors, including economic indicators, corporate earnings, geopolitical events, and investor sentiment. Predicting stock market trends has been a long-standing challenge for investors, financial analysts, and policymakers.
Traditional forecasting methods often struggle with the market’s volatility and non-linear patterns. However, advancements in machine learning (ML) have opened new possibilities for more accurate predictions. This study explores the application of ML techniques in forecasting stock market trends, leveraging historical data to enhance investment strategies and risk management.
Literature Review
Machine learning has gained significant attention in financial market predictions due to its ability to process vast amounts of data and detect complex patterns. Traditional statistical models, such as linear regression, have been used for market trend analysis but often fall short in capturing non-linear relationships (Kim, 2018). Decision trees improve upon this by handling non-linearity but are prone to overfitting (Patel et al., 2019).
Recent studies highlight deep learning techniques, such as Long Short-Term Memory (LSTM) networks, as effective tools for stock price prediction. LSTM models excel at identifying sequential dependencies in time-series data, making them well-suited for stock market forecasting (Zhang & Li, 2021). Additionally, the integration of sentiment analysis and macroeconomic indicators has been explored to improve model accuracy (Chen et al., 2020).
This study builds upon previous research by comparing traditional ML models—linear regression and decision trees—with LSTM networks to evaluate their effectiveness in predicting stock market trends.
Methodology
This study utilizes a dataset containing historical stock prices from the S&P 500 index. The following steps outline the methodology:
1. Data Collection & Preprocessing
Gather historical stock price data, including open, high, low, close, and volume.
Handle missing values and remove anomalies.
Normalize features to standardize input variables for better model performance.
2. Feature Engineering
Extract relevant features such as moving averages, volatility indicators, and momentum metrics.
Incorporate external macroeconomic factors like interest rates and inflation.
3. Model Selection
Three machine learning models were selected for comparison:
Linear Regression: Provides a baseline prediction but assumes linear relationships.
Decision Trees: Captures nonlinear interactions but may suffer from overfitting.
LSTM Networks: Handles time-series data effectively by preserving temporal dependencies.
4. Training & Evaluation
Split data into training and testing sets.
Train models using optimized hyperparameters.
Evaluate performance using metrics like Mean Absolute Error (MAE) and Root Mean Square Error (RMSE).
Results
To evaluate model accuracy, two key metrics were used:
Mean Absolute Error (MAE): Measures the average absolute difference between predicted and actual stock prices. A lower MAE indicates better accuracy.
Root Mean Squared Error (RMSE): Similar to MAE but gives more weight to larger errors. A lower RMSE means the model makes fewer large mistakes.
Model Performance
The performance of the three models is as follows:
Linear Regression: MAE = 10.23, RMSE = 15.67
Decision Trees: MAE = 9.56, RMSE = 14.23
LSTM: MAE = 8.45, RMSE = 12.56
Among the three models, the LSTM model performs the best, achieving the lowest MAE and RMSE values. This suggests that LSTM is more effective at capturing complex patterns in stock price data than Linear Regression and Decision Trees.
Discussion
The results indicate that the LSTM algorithm is well-suited for predicting stock market trends due to its ability to capture non-linear relationships and long-term dependencies. While the Decision Trees model performs reasonably well, its effectiveness is limited by its inability to generalize complex interactions.
Limitations and Future Work
Limitations
The study relies on historical data, which may not reflect future market trends.
The models may be overfitting to the training data, which could impact their performance on out-of-sample data.
Future Work
Incorporate additional features, such as economic indicators or sentiment analysis, to improve model performance.
Explore other machine learning algorithms, such as gradient boosting or random forests, to compare their performance with the LSTM model.
Evaluate the model’s performance on out-of-sample data to assess its robustness and generalizability.
Conclusion
This study demonstrates the potential of machine learning algorithms in predicting stock market trends. Among the tested models, LSTM outperforms others due to its superior ability to recognize complex patterns and temporal dependencies. These findings have significant implications for investors and financial analysts, helping them make more informed investment decisions.
DSC 2025: Advancing AI in Financial Forecasting
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