An algorithmic trading system based on a stacked generalization model and hidden Markov model in the foreign exchange market

Ali Fereydooni and Masoud Mahootchi

Global Finance Journal, 2023, vol. 56, issue C

Abstract: The Forex market has been one of the most attractive markets to researchers, funds, and traders. Literature shows that a single model algorithm usually cannot perform satisfactorily on the foreign exchange (Forex) time series because of the market's complexity. This study develops an algorithm based on two stacked generalization models consisting of four machine-learning models. First, the optimal lags of features are found using the Fisher discriminant ratio and partial autocorrelation function. Second, one stacked model fits the bullish trends, and the other holds the bearish trends resulting from a hidden Markov model. We reinforce the predictive signals of these models by extracting relationships between currency pairs with correlation and mutual information. Lastly, the proposed algorithm constructs a portfolio based on the strength of signals dependent on correlation and mutual information. As a result, this paper compares the performance of the proposed approach with different states of the model and several established benchmarks regarding return and risk metrics. The outcomes show that the proposed model's added features—such as time series clustering, considering a range of inputs, and internal relationships among different assets—can increase its performance in the Forex market.

Keywords: Foreign exchange market; Stacked generalization model; Hidden Markov model; Time series forecasting; Time series clustering (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:glofin:v:56:y:2023:i:c:s1044028323000200

DOI: 10.1016/j.gfj.2023.100825

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