In theory, we can apply regression techniques in predicting prices of a particular stock. However, it is difficult to ensure that the stock we pick is suitable enough for learning purposes—its price should follow some learnable patterns and it should not be affected by unprecedented instances or irregular events. Hence, we herein will be focusing on one of the most popular stock indexes to better illustrate and generalize our price regression approach.
Let's first cover what an index is. A stock index is a statistical measure of the value of a portion of the overall stock market. An index includes several stocks that are diverse enough to represent a section of the whole market. And the price of an index is typically computed as the weighted average of the prices of selected stocks.
The Dow Jones Industrial Average (DJIA) is one of the longest established and most commonly watched indexes in the world. It consists of 30 of the most significant stocks in the U.S., such as Microsoft, Apple, General Electric, and The Walt Disney Company, and it represents around a quarter of the value of the entire U.S. market. We can view its daily prices and performance at Yahoo Finance: https://finance.yahoo.com/quote/%5EDJI/history?p=%5EDJI:
During each trading day, the price of a stock changes and is recorded in real time. Five values illustrating movements in the price over one unit of time (usually one day, can also be one week, or one month) are key trading indicators. They are as follows:
- Open: The starting price for a given trading day
- Close: The final price on that day
- High: The highest prices at which the stock traded on that day
- Low: The lowest prices at which the stock traded on that day
- Volume: The total number of shares traded before the market is closed on that day
Other major indexes besides DJIA include:
- Standard & Poor's 500 (short for S&P 500) is made up of 500 of the most commonly traded stocks in the U.S., representing 80% of the value of the entire U.S. market (https://finance.yahoo.com/quote/%5EGSPC/history?p=%5EGSPC)
- Nasdaq Composite is composed of all stocks traded on Nasdaq (https://finance.yahoo.com/quote/%5EIXIC/history?p=%5EIXIC)
- Russell 2000 is a collection of the last 2000 out of 3000 largest publicly-traded companies in the U.S. (https://finance.yahoo.com/quote/%5ERUT/history?p=%5ERUT)
- London FTSE-100 is composed of the top 100 companies in market capitalization listed on the London Stock Exchange
We will be focusing on DJIA and using its historical prices and performance to predict future prices. In the following sections, we will be exploring how to develop price prediction models, specifically regression models, and what can be used as indicators/features.