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Forecasting Direction of Exchange Rate Fluctuations with Two Dimensional Patterns and Currency Strength

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Forecasting Direction of Exchange Rate Fluctuations with Two Dimensional Patterns and Currency Strength FORECASTING DIRECTION OF EXCHANGE RATE FLUCTUATIONS WITH TWO DIMENSIONAL PATTERNS AND CURRENCY STRENGTH A THESIS SUBMITTED TO THE GRADUATE SCHOOL OF NATURAL AND APPLIED SCIENCES OF MIDDLE EAST TECHNICAL UNIVERSITY BY MUSTAFA ONUR ÖZORHAN IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PILOSOPHY IN COMPUTER ENGINEERING MAY 2017 Approval of the thesis: FORECASTING DIRECTION OF EXCHANGE RATE FLUCTUATIONS WITH TWO DIMENSIONAL PATTERNS AND CURRENCY STRENGTH submitted by MUSTAFA ONUR ÖZORHAN in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Computer Engineering Department, Middle East Technical University by, Prof. Dr. Gülbin Dural Ünver _______________ Dean, Graduate School of Natural and Applied Sciences Prof. Dr. Adnan Yazıcı _______________ Head of Department, Computer Engineering Prof. Dr. İsmail Hakkı Toroslu _______________ Supervisor, Computer Engineering Department, METU Examining Committee Members: Prof. Dr. Tolga Can _______________ Computer Engineering Department, METU Prof. Dr. İsmail Hakkı Toroslu _______________ Computer Engineering Department, METU Assoc. Prof. Dr. Cem İyigün _______________ Industrial Engineering Department, METU Assoc. Prof. Dr. Tansel Özyer _______________ Computer Engineering Department, TOBB University of Economics and Technology Assist. Prof. Dr. Murat Özbayoğlu _______________ Computer Engineering Department, TOBB University of Economics and Technology Date: ___24.05.2017___ I hereby declare that all information in this document has been obtained and presented in accordance with academic rules and ethical conduct. I also declare that, as required by these rules and conduct, I have fully cited and referenced all material and results that are not original to this work. Name, Last name: MUSTAFA ONUR ÖZORHAN Signature: iv ABSTRACT FORECASTING DIRECTION OF EXCHANGE RATE FLUCTUATIONS WITH TWO DIMENSIONAL PATTERNS AND CURRENCY STRENGTH Özorhan, Mustafa Onur Ph.D., Department of Computer Engineering Supervisor: Prof. Dr. İsmail Hakkı Toroslu May 2017, 110 pages The value of a country’s currency is expressed in terms of other countries’ currencies. That value is called an exchange rate. Many currencies are freely floating and do not have a fixed value that is pegged by the central bank of a country. The value of currencies are determined in the foreign exchange market (Forex). Forex market is an extensive trading ground for traders across the world. It is available for trade 24 hours a day, 5 days a week. The trade volume per day is in excess of 4 trillion USD. Many different bilateral currency pairs are traded in the Forex market. In the Forex market a trader can profit from predicting the direction and magnitude of price fluctuations of a currency pair. Using a leverage value, it is possible to multiply wins and losses. Technical indicators are statistical metrics whose values are calculated from price history of financial instrument. Technical indicators are generated to represent the v behavior of the price and they are used to determine the future trend of the price of the financial instrument. Chart patterns are two-dimensional formations that appear on a financial instrument’s price-action chart. Chartists and traders use these patterns to identify the cur-rent trends of the instrument to trigger buy and sell signals. This thesis presents a method to predict the direction and magnitude of movement of currency pairs in the foreign exchange market. The method uses clustering and classification methods with a combination of two dimensional chart patterns, processed price data and technical indicator data. The input data is adapted to each trading day with a moving time-frame. The accuracy of the prediction models are tested across several different currency pairs. The experimental results suggest that using two dimensional chart patterns mixed with processed price data and the Zigzag technical indicator improves overall performance and adapting the input data to each trading period results in increased accuracy and profits. The predictions should be applicable in real world, since trading concepts such as spreads, swap commissions and leverages are taken into account. Keywords: forex, forecasting, support vector machines, technical indicators, zigzag, chart patterns, motifs vi ÖZ DÖVİZ KURU DALGALANMA YÖNÜNÜN İKİ BOYUTLU ÖRÜNTÜLER VE PARA BİRİMİ GÜCÜ İLE ÖNCEDEN TAHMİNLENMESİ Özorhan, Mustafa Onur Doktora, Bilgisayar Mühendisliği Bölümü Tez Yöneticisi: Prof. Dr. İsmail Hakkı Toroslu Mayıs 2017, 110 sayfa Ülkelerin para birimlerinin değerleri başka ülkelerin para birimlerinin değerleri cinsinden ölçülmektedir. Bu ölçüme parite denmektedir. Günümüzde pek çok para birimi dalgalı kur rejiminde serbestçe dalgalanmaktadır ve ülke merkez bankasınca başka bir para biriminin değerine sabitlenmemektedir. Para birimlerinin değerleri yabancı para takas pazarı (Foreks) pazarında belirlenmektedir. Foreks pazarı tüm dünyadan katılımcıların işlem yaptığı bir işlem platformudur. Haftanın 5 günü, 24 saat boyunca açıktır. Günlük işlem hacmi 4 trilyon ABD dolarından daha fazladır. Foreks pazarında pek çok para birimi ikilisi işlem görmektedir. Foreks pazarında işlem yapanlar para birimi ikililerinin değerlerinde meydana gelecek hareketlerin yönünü ve büyüklüğünü önceden tespit ederek kazanç elde edebilmektedir. Bir kaldıraç değeri kullanılarak, kazançlar ve kayıplar katlanabilmektedir. vii Teknik indikatörler finansal bir enstrümanın önceki değerlerinden hesaplanan istatistiksel metriklerdir. Teknik indikatörler fiyatın davranışını temsil etmek için yaratılırlar ve finansal enstrümanın gelecek fiyat trendini belirlemekte kullanılırlar. Grafik desenleri finansal bir enstrümanın fiyat-hareket grafiğinde meydana gelen iki- boyutlu oluşumlardır. Grafikçiler ve işlem yapanlar bu desenleri kullanarak enstrümanın mevcut trendini tespit eder ve alım satım sinyalleri yaratırlar. Bu tezde yabancı para takas pazarındaki para birimlerinin hareketlerinin büyüklük ve yönlerinin tahmini için bir yöntem önerilmektedir. Yöntem kümeleme ve sınıflandırma tekniklerinin iki boyutlu grafik desenleri, işlenmiş fiyat verisi ve teknik indikatör verisi ile birleştirilmesinden faydalanmaktadır. Girdi verisi her bir işlem gününe kayan bir pencere ile uyarlanmaktadır. Tahmin modellerinin doğrulukları çeşitli farklı para birimi ikililerinde test edilmiştir. Deneysel sonuçlar iki boyutlu grafik desenleri, işlenmiş fiyat verisi ve Zigzag teknik indikatörünün kullanımının performansı arttırdığını, girdi verisinin her bir işlem anına adapte edilmesinin doğruluğa ve karlılığa olumlu etkilerinin olduğunu göstermektedir. Tahminler gerçek dünyada uygulanabilir olacak şekilde, fiyat aralıkları, faiz oranları ve kaldıraç oranları gibi ticari işlem kavramları dikkate alınarak yapılmaktadır. Anahtar Kelimeler: foreks, tahmin etme, destek vektör makineleri, teknik indikatörler, zigzag, grafik şablonları, motifler viii To my dearest daughter Alya. ix ACKNOWLEDGMENTS I want to express my deepest gratitude to my supervisor Prof. Dr. İsmail Hakkı Toroslu for his guidance, advice and encouragements throughout the research. One simply could not wish for a better advisor. I would like to thank my co-supervisor Dr. Onur Tolga Şehitoğlu for his meticulous contributions to my studies. I also would like to thank Assoc. Prof. Dr. Tolga Can and Assoc. Prof. Dr. Cem İyigün for their suggestions and comments. I would like to thank Assoc. Prof. Dr. Tansel Özyer and Asst. Prof. Murat Özbayoğlu for being members of my thesis examining committee. I am deeply grateful to my sweet little daughter Alya and my loving wife Esra who have been there for me at all times, my parents Nurhayat and Fatih who devoted their life to their children, for their love and support. Without them, this work could not have been completed. I would also like to thank the Central Bank of the Republic of Turkey (TCMB) and the Scientific and Technological Research Council of Turkey (TÜBİTAK) for providing the financial and temporal means throughout this study. x TABLE OF CONTENTS ABSTRACT ................................................................................................................. v ÖZ .............................................................................................................................. vii ACKNOWLEDGMENTS ........................................................................................... x TABLE OF CONTENTS ............................................................................................ xi LIST OF TABLES ..................................................................................................... xv LIST OF FIGURES ................................................................................................. xvii LIST OF ABBREVIATIONS ................................................................................... xix CHAPTERS 1 INTRODUCTION ............................................................................................ 1 1.1 Problem Definition ................................................................................... 1 1.2 Motivation and Contribution .................................................................... 3 1.3 Organization ............................................................................................. 6 2 PRELIMINARY INFORMATION ON TIME SERIES, FOREX AND TECHNICAL INDICATORS ................................................................................. 7 2.1 Time Series Preliminaries ........................................................................
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