Problem Identification How to forecast the stock price index? The stock market index direction
5
1.1. Problem Identification How to forecast the stock price index? The stock market index direction
prediction is regarded as one of the crucial issues in recent financial analysis studies Wang Choi 2013. Many techniques are employed to predict stock
prices in the stock markets but the past results are being questioned. Generally, there are three schools of thought in terms of the ability to profit
from the equity market. The first school believes that no investor can achieve above average trading advantages based on the historical and present
information. The major theories include the Random Walk Hypothesis and the Efficient Market Hypothesis Peters 1991. The Random Walk Hypothesis
states that prices on the stock market wander in a purely random and unpredictable way. Each price change occurs without any influence by past
prices. The Efficient Market Hypothesis states that the markets fully reflect all of the freely available information and prices are adjusted fully and
immediately once new information becomes available. If this is true then there should not be any benefit for prediction, because the market will react and
compensate for any action made from these available information. The second school’s view is the so-called fundamental analysis. It looks in depth at the
financial conditions and operating results of a specific company and the underlying behavior of its common stock. The value of a stock is established
by analysing the fundamental information associated with the company such as accounting, competition, and management. The fundamental factors are
overshadowed by the speculators trading. prediction is regarded as on
on e
of the cru
ci ci
al al
issues in recent financial analysis studies Wang
C Choi 2013. Many techniques are
em em
ployed to predict stock prices in
n the stock mark
ke ets
s bu
bu t
t th
th e
e pa
pa st results are
b b
eing questioned. Ge
e n
nerally, there a
a re
e thr
h ee schools of thou
gh gh
t in
in t
t er
erms of the ab bil
il ity to profit
from the he e
e qu
qu i
ity ma a
rk rk
e et
. The first school belie ve
e s
s that no
o in in
ve vest
s or can
n a
a chieve
ab b
ov ove
e aver
r a
ag e tr
ad ing advantag
es based on
th e
hi hist
s oric
i al
al a
a nd
nd pre
e se
s nt
in f
format at
io n. The maj
or theories in
cl ude the Ra
nd om Walk
Hy Hypoth
h es
es is
is and th
he Ef
E fici
ci ent Market Hypot
he sis Pet
er s 1991
. The Random
Wa a
lk l
H Hyp
ypot ot
he h
sis stat
t es
that pr ic
es on the
stoc k
ma rk
et wander in
a purely
r random a
a nd
nd un
n predictable way. Eac
h pr ic
e change
o ccur
s without any influe n
nce by y pas
st pr
pr ic
ic es. The
Effi ci
i en
en t
t Ma
Ma rk
rk et
et Hypothesis st
st at
at es
es t
t ha
ha t
t th
th e ma
rk et
s fu
ll lly
y reflect t
a al
l l
of the freely available inform rm
at t
io io
n and prices are adjusted fully
y an
an d
d im
im me
m diately once new information becomes available. If this is tru
u e
e th
then en t
t he
he re
sh s
ould ld
n t
ot b
b e
an an
y y be
benefit fo
fo r
r pr pred
ed ic
icti tio
on, beca a
us us
e e
th the
ma k
rk t
et will re reac
ac t
t and co
o mp
mp ensate
te f
f or
or any action ma a
de d
from th these available
in in
fo fo
rmation. n.
T The second
school’s view is the so-calle ed fundame
ental analysis. It looks in depth at the financial conditions and ope
erating res esults of a specific company and the
underlying behavior of its comm mon
s stock. The value of a stock is established
by analysing the fundamental infor o
mation associated with the company such
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Technical analysis assumes that the stock market moves in trends and these trends can be captured and used for forecasting. Technical analysis belongs to
the third school of thought. It attempts to use past stock price and volume information to predict future price movements The technical analyst believes
that there are recurring patterns in the market behavior that are predictable. In fact, there is not any research proved the existing of such patterns due to each
stock market has different characteristics, depending on the economies they are related to, and varying from time to time. Most of the techniques used by
technical analysts have not been shown to be statistically valid and many lack a rational explanation for their use. However, technical analysis has its value
on forecasting. Artificial Neural Networks are regarded by many as one of the more suitable
techniques for stock market forecasting Yao Tan 2001. It has been demonstrated to be an effective technique for capturing dynamic non-linear
relationships in stock markets, while technical analysis techniques unable to do so.