Study finds evidence that stock prices can be predicted within a short window of time

Feb 04, 2014 by Tom Snee

A new study from the University of Iowa shows evidence that stock price movements are, in fact, predictable during short windows.

The study by researchers in the Tippie College of Business suggests that price movements can be predicted with a better than 50-50 accuracy for anywhere up to one minute after the leaves the confines of its bid-ask spread. Probabilities continue to be significant until about five minutes after it leaves the spread. By 30 minutes, the predictability window has closed.

The researchers—Nick Street, professor of , and doctoral student Michael Rechenthin—say the work questions the generally held belief that stock cannot be predicted. While factors like news or financial reports can move stock prices, the thinking holds, nothing inherent in a price's trend line can be used to predict where the price goes next.

"This study is the first step in showing that there is predictability, and that once a price escapes the confines of the bid-ask spread, it's showing a trend," says Rechenthin, a former Chicago Stock Exchange floor trader whose dissertation looks at building models for predicting future stock price direction. "In other words, it's more than just a coin flip where the price goes."

The study examined price movements of a single stock—the S&P 500 exchange traded stock fund (SPY)—during 2005. The stock holds all 500 Standard and Poor's stocks and is considered representative of the overall U.S. market. It's also one of the most heavily traded equities on the market, with an average of more than 90,000 transactions a day during the study period, so it provides a wealth of study data.

Their analysis found no predictability of the stock's price within the bid-ask spread—that is, the space between the price that buyers are willing to pay for a stock (the bid) and the price sellers are willing to sell it for (the ask)—as the market tries to set the value of an asset. The key to their study is what happens once traders did set a value and the price escaped that spread. Once it did escape, the study tracked the stock's price at 1, 3, 5, 10, and 20 seconds, and 1, 5, and 30 minutes.

The study found the typically broke the spread after five to ten seconds, and the of its subsequent movements depended on the pattern of its most recent trades. For instance, if the stock's two most recent trades were an uptick followed by a downtick, there was a 52 percent probability the trend reversed itself within five seconds. Within 20 seconds, it had a 43 percent probability of reversal.

Rechenthin says these trends are driven only by previous trade prices because other factors that drive price—news or financial statements—cannot be incorporated into a price in such a short window.

While a 52 percent probability may not seem like much of a better probability than 50 percent, Street points out that in the ocean of data that is stock trading, it is a notable increase, and something that can be exploited. The next step is to develop a working model that takes advantage of these probabilities for more efficient trading.

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More information: The study, "Using conditional probability to identify trends in intra-day high-frequency equity pricing," was published recently in the journal Physica A.… ii/S0378437113007140

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5 / 5 (3) Feb 04, 2014
Maybe since all these trades are automated algorithms on computers, we're *introducing* predictability to a previously highly chaotic system.

Moreover, I'd love to see proposals that would make all this "gambling" trading and gaming of markets go away and have the market return to some form of "fundamentals" where we're investing in a company and hoping it does well long term.
5 / 5 (2) Feb 04, 2014
This will hardly be news to Wall Street firms that pay mathematicians ("quants") millions of dollars a year to create automated trading systems. But if a single algorithm were used by every electronic trader, that particular pattern of predictability would vanish. To envision this, imagine I have found a simple system that works every time for me: "to beat the rush-hour traffic, stay in the center lane and hold your hand on the horn button. Assuming you have an emergency, people will automatically move out of your way." But as soon as I tell the world about my new sure-thing system, the center lane, crammed full of honkers, will become the worst possible place to drive.
1 / 5 (1) Feb 04, 2014
You can play losing odds and still make money, if you walk away after winning. Money management makes profits even with random coin flipping

At the same time an article showing why most traders lose appears! http://medicalxpr...ans.html
1 / 5 (1) Feb 05, 2014
The next step is to develop a working model that takes advantage of these probabilities for more efficient trading.

"Efficient trading" is a nice little euphemism, which begs the question: who is the stock market serving? Companies seeking investors? Investors seeking companies? Or some guy in the middle? Does the stock market promote efficient use of money (i.e. in exchange for real work)? Not in as much as the guys in the middle are siphoning money out of the process.

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