Forex Trading - Using Neural Networks for Huge Profits

Today, we are seeing the increasing use of neural networks in financial markets to help forecast prices with greater accuracy and the complexity and research is mind boggling. This article will look at the use of neural networks in financial trading and their profit potential.

The Human Brain V Computers

The human brain is one of the most complex objects if not the most complex object known to man. It is not just its superior processing speed and storage space that make it extraordinary, but more importantly, its ability to learn and adapt.

Neural Networks Defined

Computer scientists have tried to write software that allows computers to mimic the learning power of the brain (computers already have superior storage and processing speed) and neural networks aim to help a computer learn and adapt.

A neural network is essentially a system of programs and data structures that approximates the operation of the human brain. A neural network consists of a large number of processors operating in parallel, each with its own sphere of knowledge and access to its own databank.

A neural network is "trained" by being given large amounts of data and a set of rules.

A computer program can then tell the network how to react in response to an external event and initiate reactions based on the knowledge it has access to.

Therefore in forex trading, neural networks can learn how to trade based upon the data fed to them.

Do They Work?

The answer is at present the human brain is and always will be superior, due to the fact it can THINK independently. A computer can never achieve the learning power of the human brain as it can only work with the rules it’s programmed with.

A computer program can trade, but do you need a neural network.

There are computer programs today, that don’t use neural networks, that have rules that make money and neural networks don’t have any advantage at all.

People think that technology can solve everything, but the markets are one area where simple systems can and do work best.

An Investment Fact

The fact is that 50 years ago 95% of forex traders lost and today the same ratio applies.

This is despite all the advances we have had in market research, computers and speed of information delivery. Keeps this point in mind if you want to win at forex trading:

Trading is an odds game and the application of science to predict is doomed to failure.

There will never be a neural network with the power to learn and adapt like the human brain, as it has to be programmed by a human and there are endless variables.

Keep it Simple For Success

If someone tries to sell you a program or service based upon neural networking, ask for their real time track record and see if you get one – chances are you wont.

People are always looking for science to help but in the markets forget neutral networks and play the odds.

Either with your brain or with a currency trading system, that’s simple with just a few rules – that’s all you need, don’t look for more.

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Applications of Neural Networks

Neural Networks in Practice

Given this description of neural networks and how they work, what real world applications are they suited for? Neural networks have broad applicability to real world business problems. In fact, they have already been successfully applied in many industries.

Since neural networks are best at identifying patterns or trends in data, they are well suited for prediction or forecasting needs including:

• sales forecasting
• industrial process control
• customer research
• data validation
• risk management
• target marketing

But to give you some more specific examples; ANN are also used in the following specific paradigms: recognition of speakers in communications; diagnosis of hepatitis; recovery of telecommunications from faulty software; interpretation of multimeaning Chinese words; undersea mine detection; texture analysis; three-dimensional object recognition; hand-written word recognition; and facial recognition.


Neural networks in medicine

Artificial Neural Networks (ANN) are currently a 'hot' research area in medicine and it is believed that they will receive extensive application to biomedical systems in the next few years. At the moment, the research is mostly on modelling parts of the human body and recognising diseases from various scans (e.g. cardiograms, CAT scans, ultrasonic scans, etc.).

Neural networks are ideal in recognising diseases using scans since there is no need to provide a specific algorithm on how to identify the disease. Neural networks learn by example so the details of how to recognise the disease are not needed. What is needed is a set of examples that are representative of all the variations of the disease. The quantity of examples is not as important as the 'quantity'. The examples need to be selected very carefully if the system is to perform reliably and efficiently.


Modelling and Diagnosing the Cardiovascular System

Neural Networks are used experimentally to model the human cardiovascular system. Diagnosis can be achieved by building a model of the cardiovascular system of an individual and comparing it with the real time physiological measurements taken from the patient. If this routine is carried out regularly, potential harmful medical conditions can be detected at an early stage and thus make the process of combating the disease much easier.

A model of an individual's cardiovascular system must mimic the relationship among physiological variables (i.e., heart rate, systolic and diastolic blood pressures, and breathing rate) at different physical activity levels. If a model is adapted to an individual, then it becomes a model of the physical condition of that individual. The simulator will have to be able to adapt to the features of any individual without the supervision of an expert. This calls for a neural network.

Another reason that justifies the use of ANN technology, is the ability of ANNs to provide sensor fusion which is the combining of values from several different sensors. Sensor fusion enables the ANNs to learn complex relationships among the individual sensor values, which would otherwise be lost if the values were individually analysed. In medical modelling and diagnosis, this implies that even though each sensor in a set may be sensitive only to a specific physiological variable, ANNs are capable of detecting complex medical conditions by fusing the data from the individual biomedical sensors.


Electronic noses

ANNs are used experimentally to implement electronic noses. Electronic noses have several potential applications in telemedicine. Telemedicine is the practice of medicine over long distances via a communication link. The electronic nose would identify odours in the remote surgical environment. These identified odours would then be electronically transmitted to another site where an door generation system would recreate them. Because the sense of smell can be an important sense to the surgeon, telesmell would enhance telepresent surgery.


Instant Physician

An application developed in the mid-1980s called the "instant physician" trained an autoassociative memory neural network to store a large number of medical records, each of which includes information on symptoms, diagnosis, and treatment for a particular case. After training, the net can be presented with input consisting of a set of symptoms; it will then find the full stored pattern that represents the "best" diagnosis and treatment.


Neural Networks in business

Business is a diverted field with several general areas of specialisation such as accounting or financial analysis. Almost any neural network application would fit into one business area or financial analysis.

There is some potential for using neural networks for business purposes, including resource allocation and scheduling. There is also a strong potential for using neural networks for database mining, that is, searching for patterns implicit within the explicitly stored information in databases. Most of the funded work in this area is classified as proprietary. Thus, it is not possible to report on the full extent of the work going on. Most work is applying neural networks, such as the Hopfield-Tank network for optimization and scheduling.


Marketing

There is a marketing application which has been integrated with a neural network system. The Airline Marketing Tactician (a trademark abbreviated as AMT) is a computer system made of various intelligent technologies including expert systems. A feedforward neural network is integrated with the AMT and was trained using back-propagation to assist the marketing control of airline seat allocations. The adaptive neural approach was amenable to rule expression. Additionaly, the application's environment changed rapidly and constantly, which required a continuously adaptive solution. The system is used to monitor and recommend booking advice for each departure. Such information has a direct impact on the profitability of an airline and can provide a technological advantage for users of the system. [Hutchison & Stephens, 1987]

While it is significant that neural networks have been applied to this problem, it is also important to see that this intelligent technology can be integrated with expert systems and other approaches to make a functional system. Neural networks were used to discover the influence of undefined interactions by the various variables. While these interactions were not defined, they were used by the neural system to develop useful conclusions. It is also noteworthy to see that neural networks can influence the bottom line.


Credit Evaluation

The HNC company, founded by Robert Hecht-Nielsen, has developed several neural network applications. One of them is the Credit Scoring system which increase the profitability of the existing model up to 27%. The HNC neural systems were also applied to mortgage screening. A neural network automated mortgage insurance underwritting system was developed by the Nestor Company. This system was trained with 5048 applications of which 2597 were certified. The data related to property and borrower qualifications. In a conservative mode the system agreed on the underwritters on 97% of the cases. In the liberal model the system agreed 84% of the cases. This is system run on an Apollo DN3000 and used 250K memory while processing a case file in approximately 1 sec.

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Architecture of Neural Networks

Feed-forward networks

Feed-forward ANNs (figure 1) allow signals to travel one way only; from input to output. There is no feedback (loops) i.e. the output of any layer does not affect that same layer. Feed-forward ANNs tend to be straight forward networks that associate inputs with outputs. They are extensively used in pattern recognition. This type of organisation is also referred to as bottom-up or top-down.

Feedback networks

Feedback networks can have signals travelling in both directions by introducing loops in the network. Feedback networks are very powerful and can get extremely complicated. Feedback networks are dynamic; their 'state' is changing continuously until they reach an equilibrium point. They remain at the equilibrium point until the input changes and a new equilibrium needs to be found. Feedback architectures are also referred to as interactive or recurrent, although the latter term is often used to denote feedback connections in single-layer organisations.

Simple feed forward network Complicated Network


















Network layers

The commonest type of artificial neural network consists of three groups, or layers, of units: a layer of "input" units is connected to a layer of "hidden" units, which is connected to a layer of "output" units.

* The activity of the input units represents the raw information that is fed into the network.

* The activity of each hidden unit is determined by the activities of the input units and the weights on the connections between the input and the hidden units.

* The behaviour of the output units depends on the activity of the hidden units and the weights between the hidden and output units.

This simple type of network is interesting because the hidden units are free to construct their own representations of the input. The weights between the input and hidden units determine when each hidden unit is active, and so by modifying these weights, a hidden unit can choose what it represents.

We also distinguish single-layer and multi-layer architectures. The single-layer organisation, in which all units are connected to one another, constitutes the most general case and is of more potential computational power than hierarchically structured multi-layer organisations. In multi-layer networks, units are often numbered by layer, instead of following a global numbering.

Perceptrons

The most influential work on neural nets in the 60's went under the heading of 'perceptrons' a term coined by Frank Rosenblatt. The perceptron turns out to be an MCP model ( neuron with weighted inputs ) with some additional, fixed, pre--processing. Units labelled A1, A2, Aj , Ap are called association units and their task is to extract specific, localised featured from the input images. Perceptrons mimic the basic idea behind the mammalian visual system. They were mainly used in pattern recognition even though their capabilities extended a lot more.

In 1969 Minsky and Papert wrote a book in which they described the limitations of single layer Perceptrons. The impact that the book had was tremendous and caused a lot of neural network researchers to loose their interest. The book was very well written and showed mathematically that single layer perceptrons could not do some basic pattern recognition operations like determining the parity of a shape or determining whether a shape is connected or not. What they did not realised, until the 80's, is that given the appropriate training, multilevel perceptrons can do these operations.

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Human and Artificial Neurones - investigating the similarities

How the Human Brain Learns?

Much is still unknown about how the brain trains itself to process information, so theories abound. In the human brain, a typical neuron collects signals from others through a host of fine structures called dendrites. The neuron sends out spikes of electrical activity through a long, thin stand known as an axon, which splits into thousands of branches. At the end of each branch, a structure called a synapse converts the activity from the axon into electrical effects that inhibit or excite activity from the axon into electrical effects that inhibit or excite activity in the connected neurones. When a neuron receives excitatory input that is sufficiently large compared with its inhibitory input, it sends a spike of electrical activity down its axon. Learning occurs by changing the effectiveness of the synapses so that the influence of one neuron on another changes.












Components of a neuron The synapse


From Human Neurones to Artificial Neurones

We conduct these neural networks by first trying to deduce the essential features of neurones and their interconnections. We then typically program a computer to simulate these features. However because our knowledge of neurones is incomplete and our computing power is limited, our models are necessarily gross idealisations of real networks of neurones.

The neuron model

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Introduction to Neural Networks

What is a Neural Network?

An Artificial Neural Network (ANN) is an information processing paradigm that is inspired by the way biological nervous systems, such as the brain, process information. The key element of this paradigm is the novel structure of the information processing system. It is composed of a large number of highly interconnected processing elements (neurones) working in unison to solve specific problems. ANNs, like people, learn by example. An ANN is configured for a specific application, such as pattern recognition or data classification, through a learning process. Learning in biological systems involves adjustments to the synaptic connections that exist between the neurones. This is true of ANNs as well.

Historical background

Neural network simulations appear to be a recent development. However, this field was established before the advent of computers, and has survived at least one major setback and several eras.

Many importand advances have been boosted by the use of inexpensive computer emulations. Following an initial period of enthusiasm, the field survived a period of frustration and disrepute. During this period when funding and professional support was minimal, important advances were made by relatively few reserchers. These pioneers were able to develop convincing technology which surpassed the limitations identified by Minsky and Papert. Minsky and Papert, published a book (in 1969) in which they summed up a general feeling of frustration (against neural networks) among researchers, and was thus accepted by most without further analysis. Currently, the neural network field enjoys a resurgence of interest and a corresponding increase in funding.

The first artificial neuron was produced in 1943 by the neurophysiologist Warren McCulloch and the logician Walter Pits. But the technology available at that time did not allow them to do too much.

Why use neural networks?

Neural networks, with their remarkable ability to derive meaning from complicated or imprecise data, can be used to extract patterns and detect trends that are too complex to be noticed by either humans or other computer techniques. A trained neural network can be thought of as an "expert" in the category of information it has been given to analyse. This expert can then be used to provide projections given new situations of interest and answer "what if" questions.
Other advantages include:

Adaptive learning:
An ability to learn how to do tasks based on the data given for training or initial experience.

Self-Organisation:
An ANN can create its own organisation or representation of the information it receives during learning time.

Real Time Operation:
ANN computations may be carried out in parallel, and special hardware devices are being designed and manufactured which take advantage of this capability.

Fault Tolerance via Redundant Information Coding:
Partial destruction of a network leads to the corresponding degradation of performance. However, some network capabilities may be retained even with major network damage.

Neural networks versus conventional computers

Neural networks take a different approach to problem solving than that of conventional computers. Conventional computers use an algorithmic approach i.e. the computer follows a set of instructions in order to solve a problem. Unless the specific steps that the computer needs to follow are known the computer cannot solve the problem. That restricts the problem solving capability of conventional computers to problems that we already understand and know how to solve. But computers would be so much more useful if they could do things that we don't exactly know how to do.

Neural networks process information in a similar way the human brain does. The network is composed of a large number of highly interconnected processing elements(neurones) working in parallel to solve a specific problem. Neural networks learn by example. They cannot be programmed to perform a specific task. The examples must be selected carefully otherwise useful time is wasted or even worse the network might be functioning incorrectly. The disadvantage is that because the network finds out how to solve the problem by itself, its operation can be unpredictable.

On the other hand, conventional computers use a cognitive approach to problem solving; the way the problem is to solved must be known and stated in small unambiguous instructions. These instructions are then converted to a high level language program and then into machine code that the computer can understand. These machines are totally predictable; if anything goes wrong is due to a software or hardware fault.

Neural networks and conventional algorithmic computers are not in competition but complement each other. There are tasks are more suited to an algorithmic approach like arithmetic operations and tasks that are more suited to neural networks. Even more, a large number of tasks, require systems that use a combination of the two approaches (normally a conventional computer is used to supervise the neural network) in order to perform at maximum efficiency.

Neural networks do not perform miracles.
But if used sensibly they can produce some amazing results.

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