A Survey of Deep Learning

Techniques Applied to Trading

Published on July 31, 2016

by Greg Harris

http://gregharris.info/a-survey-of-deep-learning-techniques-applied-t
o-trading/

Deep learning has been getting a lot of attention lately with

breakthroughs in image classification and speech recognition.
However, its application to finance doesn’t yet seem to be
commonplace. This survey covers what I’ve found so far that is
relevant to systematic trading. Please tell me if you know of some
research I’ve missed.

Acronyms:

DBN = Deep Belief Network

LSTM = Long Short-Term Memory

MLP = Multi-layer Perceptron

RBM = Restricted Boltzmann Machine

ReLU = Rectified Linear Units

CNN = Convolutional Neural Network

Limit Order Book Modeling

Sirignano (2016) predicts changes in limit order books. He has

developed a “spatial neural network” that can take advantage of
local spatial structure, is more interpretable, and more
computationally efficient than a standard neural network for this
purpose. He models the joint distribution of the best bid and ask at
the time of the next state change. Also, he models the joint
distribution of the best bid and ask prices upon the change in either of
them.

Architecture – Each neural network has 4 layers. The standard

neural network has 250 neurons per hidden layer, and the spatial
neural network has 50. He uses the tanh activation function on the
hidden layer neurons.

Training – He trained and tested on order books from 489 stocks

from 2014 to 2015 (a separate model for each stock). He uses Level III
limit order book data from the NASDAQ with event times having
nanosecond decimal precision. Training involved 50TB of data and
used a cluster with 50 GPUs. He includes 200 features: the price and
size of the limit order book across the first 50 non-zero bid and ask
levels. He uses dropout to prevent overfitting. He uses batch
normalization between each hidden layer to prevent internal
covariate shift. Training is done with the RMSProp algorithm.
RMSProp is similar to stochastic gradient descent with momentum
but it normalizes the gradient by a running average of the past
gradients. He uses an adaptive learning rate where the learning rate
is decreased by a constant factor whenever the training error
increases over a training epoch. He uses early stopping imposed via a
validation set to reduce overfitting. He also includes an l^2 penalty
when training in order to reduce overfitting.

Results – He shows that limit order books exhibit some degree of

local spatial structure. He predicts the order book 1 second ahead
and also at the time of the next bid/ask change. The spatial neural
network outperforms the standard neural network and logistic
regression with non-linear features. Both neural networks have 10%
lower error than logistic regression.

Price-based Classification Models

Dixon et al. (2016) use a deep neural network to predict the sign of
the price change over the next 5 minutes for 43 commodity and forex
futures.

Architecture – Their input layer has 9,896 neurons for input features
made up of lagged price differences and co-movements between
contracts. There are 5 learned fully-connected layers. The first of the
four hidden layers contains 1,000 neurons, and each subsequent
layer tapers by 100 neurons. The output layer has 135 neurons (3 for
each class {-1, 0, 1} times 43 contracts).

Training – They used the standard back-propagation with stochastic

gradient descent. They speed up training by using mini-batching
(computing the gradient on several training examples at once rather
than individual examples). Rather than an nVidia GPU, they used an
Intel Xeon Phi co-processor.

Results – They report 42% accuracy, overall, for three-class

classification. They do some walk-forward training instead of a
traditional backtest. Their boxplot shows some generally positive
Sharpe ratios from the mini-backtests for each contract. They did not
include transaction costs or crossing the bid-ask spread. All their
predictions and features were based on the mid-price at the end of
each 5-minute time period.

Takeuchi and Lee (2013) look to enhance the momentum effect by

predicting which stocks will have higher or lower monthly returns
than the median.

Architecture – They use an auto-encoder composed of stacked

RBMs to extract features from stock prices which they then pass to a
feed-forward neural network classifier. Each RBM consists of one
layer of visible units and one layer of hidden units connected by
symmetric links. The first layer has 33 units for input features from
one stock at a time. For every month t, the features include the 12
monthly returns for month t-2 through t-13 and the 20 daily returns
approximately corresponding to month t. They normalize each of the
return features by calculating the z-score relative to the cross-section
of all stocks for each month or day. The number of hidden units in the
final layer of the encoder is sharply reduced, forcing dimensionality
reduction. The output layer has 2 units, corresponding to whether the
stock ended up above or below the median return for the month. Final
layer sizes are 33-40-4-50-2.

Training – During pre-training, they split the dataset into smaller,

non-overlapping mini-batches. Afterwards, they un-roll the RBMs to
form an encoder-decoder, which is fine-tuned using back-propagation.
They consider all stocks trading on the NYSE, AMEX, or NASDAQ with
a price greater than $5. They train on data from 1965 to 1989
(848,000 stock-month samples) and test on data from 1990 to 2009
(924,300 stock-month samples). Some training data held-out for
validation for the number of layers and the number of units per layer.
Results – Their overall accuracy is around 53%. When they consider
the difference between the top decile and the bottom decile
predictions, they get 3.35% per month, or 45.93% annualized return.

Batres-Estrada (2015) predicts which S&P 500 stocks will have

above-median returns for each given day, and his work appears to be
heavily influenced by Takeuchi and Lee (2013).

Architecture – He uses a 3-layer DBN coupled to an MLP. He uses

400 neurons in each hidden layer, and he uses a sigmoid activation
function. The output layer is a softmax layer with two output neurons
for binary classification (above median or below). The DBN is
composed of stacked RBMs, each trained sequentially.

Training – He first pre-trains the DBN module, then fine-tunes the

entire DBN-MLP using back-propagation. The input includes 33
features: monthly log-returns for months t-2 to t-13, 20 daily
log-returns for each stock at month t, and an indicator variable for the
January effect. The features are normalized using the Z-score for each
time period. He uses S&P 500 constituent data from 1985 to 2006
with a 70-15-15 split for training-validataion-test. He uses the
validation data to choose the number of layers, the number of
neurons, and the regularization parameters. He uses early-stopping
to prevent over-fitting.

Results – His model has 53% accuracy, which outperforms

regularized logistic regression and a few MLP baselines.

Sharang and Rao (2015) use a DBN trained on technical indicators to

trade a portfolio of US Treasury note futures.

Architecture – They use a DBN consisting of 2 stacked RBMs. The

first RBM is Gaussian-Bernoulli (15 nodes), and the second RBM is
Bernoulli (20 nodes). The DBN produces latent features which they try
feeding into three different classifiers: regularized logistic regression,
support vector machines, and a neural network with 2 hidden layers.
They predict 1 if portfolio goes up over 5 days, and -1 otherwise.

Training – They train the DBN using a contrastive divergence

algorithm. They calculate signals based on open, high, low, close,
open interest, and volume data, beginning in 1985, with some points
removed during the 2008 financial crisis. They use 20 features: the
“daily trend” calculated over different time frames, and then
normalized. All parameters are chosen using a validation dataset.
When training the neural net classifier, they mention using a
momentum parameter during mini-batch gradient descent training to
shrink the coefficients by half during every update.

Results – The portfolio is constructed using PCA to be neutral to the

first principal component. The portfolio is an artificial spread of
instruments, so actually trading it is done with a spread between the
ZF and ZN contracts. All input prices are mid-prices, meaning the
bid-ask spread is ignored. The results look profitable, with all three
classification models performing 5-10% more accurately than a
random predictor.

Zhu et al. (2016) make trade decisions using oscillation box theory
based on DBNs. Oscillation box theory says that a stock price will
oscillate within a certain range in a period of time. If the price moves
outside the range, then it enters into a new box. The authors try to
predict the boundaries of the box. Their trading strategy is to buy the
stock when it breaks through the top boundary or sell it when it
breaks through the bottom boundary.

Architecture – They use a DBN made up of stacked RBMs and a final

back-propagation layer.

Training – They used block Gibbs sampling to greedily train each

layer from lowest to highest in an unsupervised way. They then train
the back-propagation layer in a supervised way, which fine-tunes the
whole model. They chose 400 stocks out of the S&P 500 for testing,
and the test set covers 400 days from 2004 to 2005. They use open,
high, low, close prices as well as technical analysis indicators, for a
total of 14 model inputs. Some indicators are given more influence in
the prediction through the use of “gray relation analysis” or “gray
correlation degree.”

Results – In their trading strategy, they charge 0.5% transaction

costs per trade and add a couple of parameters for stop-loss and
“transaction rate.” I don’t fully understand the result tables, but they
seem to be reporting significant profits.

Text-based Classification Models

Rönnqvist and Sarlin (2016) predict bank distress using news articles.
Specifically, they create a classifier to judge whether a given
sentence indicates distress or tranquility.
Architecture – They use two neural networks in this paper. The first
is for semantic pre-training to reduce dimensionality. For this, they
run a sliding window over text, taking a sequence of 5 words and
learning to predict the next word. They use a feed-forward topology
where a projection layer in the middle provides the semantic vectors
once the connection weights have been learned. They also include
the sentence ID as an input to the model, to provide context and
inform the prediction of the next word. They use binary Huffman
coding to map sentence IDs and word to activation patterns in the
input layer, which organizes the words roughly by frequency. They
say feed-forward topologies with fixed context sizes are more
efficient than recurrent neural networks for modeling text sequences.
The second neural network is for classification. Instead of a million
inputs (one for each word), they use 600 inputs from the learned
semantic model. The first layer has 600 nodes, the middle layer has
50 rectified linear hidden nodes, and the output layer has 2 nodes
(distress/tranquil).

Training – They train it with 243 distress events over 101 banks
observed during the financial crisis of 2007-2009. They use 716k
sentences mentioning the banks, taken from 6.6m Reuters news
articles published during and after the crisis.

Results – They evaluate their classification model using a custom

“Usefulness” measure. The evaluation is done using cross-validation,
leaving N banks out in each fold. They aggregate the distress counts
into various timeseries but don’t go so far as to consider creating a
trading strategy.

Fehrer and Feuerriegel (2015) train a model to predict German stock

returns based on headlines.

Architecture – They use a recursive autoencoder with an additional

softmax layer in each autoencoder for estimating probabilities. They
perform three-class prediction {-1, 0, 1} for the following day’s return
of the stock associated with the headline.

Training – They initialize the weights with Gaussian noise, and then
update through back-propagation. They use an English ad-hoc news
announcement dataset (8,359 headlines) for the German market
covering 2004 to 2011.

Results – Their recursive autoencoder has 56% accuracy, which in

an improvement over a more traditional random forest modeling
approach with 53% accuracy. They do not develop a trading strategy.
They have made a Java implementation of their code publicly
available.

Ding et al. (2015) use structured information extracted from

headlines to predict daily S&P 500 moves. Headlines are processed
with Open IE to obtain structured event representations (actor, action,
object, time). A neural tensor network learns the semantic
compositionality over event arguments by combining them
multiplicatively instead of only implicitly, as with standard neural
networks.

Architecture – They combine short-term and long-term effects of

events, using a CNN to perform semantic composition over the input
event sequence. They use a max pooling layer on top of the
convolutional layer, which makes the network retain only the most
useful features produced by the convolutional layer. They have
separate convolutional layers for long-term events and mid-term
events. Both of these layers, along with an input layer for short-term
events, feed into a hidden layer which then feeds into two output
nodes.

Training – They extracted 10 million events from Reuters and

Bloomberg news. For training, they corrupt events by replacing one
event argument with a random argument. During training, they
assume that the actual event should be given a higher score than the
corrupted event. When it isn’t, model parameters get updated.

Results – They find that structured events are better features than
words for stock market prediction. Their approach outperforms
baseline methods by 6%. They make predictions for the S&P 500
index and 15 individual stocks, and a table appears to show that they
can predict the S&P 500 with 65% accuracy.

Volatility Prediction

Xiong et al. (2015) predict the daily volatility of the S&P 500, as
estimated from open, high, low, close prices.

Architecture – They use a single LSTM hidden layer consisting of

one LSTM block. For inputs they use daily S&P 500 returns and
volatilities. They also include 25 domestic Google trends, covering
sectors and major areas of the economy.
Training – They used the “Adam” method with 32 samples per batch
and mean absolute percent error (MAPE) as the objective loss
function. They set the maximum lag of the LSTM to include 10
successive observations.

Results – They show their LSTM method outperforms GARCH, Ridge,

and LASSO techniques.

Portfolio Optimization

Heaton et al. (2016) attempt to create a portfolio that outperforms

the biotech index IBB. They have the goal of tracking the index with
few stocks and low validation error. They also try to beat the index by
being anti-correlated during periods of large drawdowns. They don’t
directly model the covariance matrix, rather it is trained in the deep
architecture fitting procedure, which allows for nonlinearities.

Architecture – They use auto-encoding with regularization and

ReLUs. Their auto-encoder has one hidden layer with 5 neurons.

Training – They use weekly return data for the component stocks of
IBB from 2012 to 2016. They auto-encode all stocks in the index and
evaluate the difference between each stock and its auto-encoded
version. They keep the 10 most “communal” stocks that are most
similar to the auto-encoded version. They also keep a varying number
of other stocks, where the number is chosen with cross-validation.

Results – They show the tracking error as a function of the number

stocks included in the portfolio, but don’t seem to compare against
traditional methods. They also replace index drawdowns with positive
returns and find portolios that track this modified index.

Related Links

Stock Market Forecasting using deep learning? (reddit.com)

deep learning in finance (reddit.com)

Leveraging Google DeepMind software and Deep Learning to play the

stock market(reddit.com)
They might be Robots, Using data for investment management and
trading (youtube.com)

Introducing Binatix: A Deep Learning Trading Firm That’s Already

Profitable (recode.net)

Will AI-Powered Hedge Funds Outsmart the

Market? (technologyreview.com)

Adaptive deep learning empowers traders (automatedtrader.net)

Deep Learning in Finance (slideshare.net)

Prediction of Exchange Rate Using Deep Neural

Network (slideshare.net)

References

Batres-Estrada, B. (2015). Deep learning for multivariate financial

time series. abstract

Ding, X., Zhang, Y., Liu, T., & Duan, J. (2015, June). Deep learning for
event-driven stock prediction. In Proceedings of the Twenty-Fourth
International Joint Conference on Artificial Intelligence (ICJAI) (pp.
2327-2333). abstract

Dixon, M. F., Klabjan, D., & Bang, J. H. (2016). Classification-based

Financial Markets Prediction using Deep Neural Networks. Available
at SSRN 2756331. abstract

Fehrer, R., & Feuerriegel, S. (2015). Improving Decision Analytics with

Deep Learning: The Case of Financial Disclosures. arXiv preprint
arXiv:1508.01993. abstract

Heaton, J. B., Polson, N. G., & Witte, J. H. (2016). Deep Portfolio Theory.
arXiv preprint arXiv:1605.07230. abstract

Rönnqvist, S., & Sarlin, P. (2016). Bank distress in the news:

Describing events through deep learning. arXiv preprint
arXiv:1603.05670. abstract

Sharang, A., & Rao, C. (2015). Using machine learning for medium
frequency derivative portfolio trading. arXiv preprint
arXiv:1512.06228. abstract
Sirignano, J. A. (2016). Deep Learning for Limit Order Books. arXiv
preprint arXiv:1601.01987. abstract

Takeuchi, L., Lee, Y. (2013). Applying Deep Learning to Enhance

Momentum Trading Strategies in Stocks. abstract

Xiong, R., Nicholas, E. P., & Shen, Y. (2015). Deep Learning Stock
Volatilities with Google Domestic Trends. arXiv preprint
arXiv:1512.04916. abstract

Zhu, C., Yin, J., & Li, Q. (2014). A stock decision support system based
on DBNs. Journal of Computational Information Systems, 10(2),
883-893. abstract·