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Assumptions
Stock price reflects everything that has or could affect a
the company (including fundamental factors and market
psychology), removing the need to consider these factors
separately.
Price movements follow established trends.
History repeat itself.
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Problems
Patterns of financial time series are dynamic and
complex.
We need to balance between long-term trends and
short-term sideways.
We need to determine usefulness of information.
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We need:
A financial expert could apply different unknown
strategies. We can model this by considering a set of
states where each state is a unknown strategy
We can make different observations regarding the time
series evolution with each strategy. We will need set of
observations K. Observations could be Rise, Drop, Large
Rise
Which strategy we will first apply? A vector of the initial
state distribution probability.
Which strategy is most likely to be applied next? A
matrix that contain transition probabilities between states
(strategies).
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Problems
One observation like the return rate, or LR is not
enough. We need to feed our machine with vectors of
observations containing for example price and volume.
Also how do we model data more accurately? For each
state we could build more probability functions that
describe the data (from different views); also we need to
quantify all of this probability distributions and to estimate
each distributions weight into the final quantity.
How to smooth the time series, do we eliminate noise
than can confuse the interpretation?
More recent data should be more valuable, that is more
sensitive. But if the recent data is in highly volatile period
how do we treat this situation so the model wouldnt be
affected in the training process?
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Re-estimation of parameters
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