Intelligent Data Engineering and Automated

Learning - IDEAL 2004

5th International Conference, Exeter, UK

Wavelet Multi-resolution
Analysis of High
Frequency FX Rates
Department of Computing
University of Surrey, Guildford, UK
August 27, 2004

Talk Outline

Describing Time Series Data

Financial Time Series Data Characteristics
Wavelet Multiscale Analysis
Our Time Series Analysis Approach
- Algorithms
- Prototype System
- Case Study
- Conclusions
Questions

What Is a Time Series?

A chronologically arranged sequence of
data on a particular variable
Obtained at regular time interval
Assumes that factors influencing past and
present will continue

U.S. Retail Sales

Quarterly Data
450
Sales (Billions)

400
350
300
250
200
83

84

85

86
Year

87

Time Series Components

Trend
Seasonal

TS Data
Irregular

Cyclical

Trend Component
Indicates the very long-term behavior of the
time series
Typically as a straight line or an exponential
curve
This is useful in seeing the overall picture

Cyclical Component

A non-seasonal component which varies in a

recognizable period

Peak
Contraction
Trough
Expansion

Time

Due to interactions of economic factors

The cyclic variation is especially difficult to
forecast beyond the immediate future more of a
local phenomenon

Seasonal Component

Regular pattern of up and down fluctuations within

a fixed time

Time

Due to weather, customs etc.

Periods of fluctuations more regular, hence more
profitable for forecasting

Irregular Component
Random, unsystematic, residual
fluctuations
Due to random variation or unforeseen
events
Short duration and non-repeating
A forecast, even in the best situation, can be
no closer (on average) than the typical size
of the irregular variation

Time Series Data Broken-Down*

TS Data
Trend
Cyclic Behavior
Seasonal Index
Irregular

*For illustration purposes only.

Financial Time Series

Data Characteristics

Evolve in a nonlinear fashion over time

Exhibit quite complicated patterns, like trends,

abrupt changes, and volatility clustering, which
appear, disappear, and re-appear over time
nonstationary

There may be purely local changes in time domain,

global changes in frequency domain, and there may
be changes in the variance parameters

Financial Time Series

Data Characteristics
585
545

IBM Prices

505
465

Nonstationary

425
385
345
305
1

26

51

76

101

126

151

176

201

226

251

276

301

326

351

0.1

IBM Volatility

0.08

0.06

Time Varying
Volatility

0.04

0.02

0
1

26

51

76

101

126

151

176

201

226

251

276

301

326

351

Financial Time Series

Data Characteristics
Having said that

The nonlinearities and nostationarities do contain

certain regularities or patterns

Therefore, an analysis of nonlinear time series

data would involve quantitatively capturing such
regularities or patterns effectively

How and Why?

Wavelet Multiscale Analysis

Overview

Wavelets are mathematical functions that cut up

data into different frequency components and then
study each component with a resolution matched
to its scale

Wavelets are treated as a lens that enables the

researcher to explore relationships that were
previously unobservable

Provides a unique decomposition (deconstruction)

of a time series in ways that are potentially
revealing

Wavelet Multiscale Analysis

Step I: Take a wavelet and compare it to a section at the start of the
original signal. Calculate C to measure closeness (correlation) of
wavelet with signal

Signal

Wavelet

C = C1

Wavelet Multiscale Analysis

Step II: Keep shifting the wavelet to the right and repeating Step I until
whole signal is covered

Signal

Wavelet

C = C2

Wavelet Multiscale Analysis

Step III: Scale (stretch) the wavelet and repeat Steps I & II
Signal

Wavelet

C = C3

Step IV: Repeat Steps I to III for all scales

Wavelet Multiscale Analysis

Filter Bank Approach
Discrete Convolution: The original signal is convolved with a set of
high or low pass filters corresponding to the prototype wavelet

w* xt wi xt i
i
Xt Original Signal
W High or low pass filters

Wavelet Multiscale Analysis

Filter Bank Approach

Iteration gives scaling effect

at each level

H: Bank of High Pass filters

Xt

H* (f)

D1

G (f)

H (f) high-pass decomposition filter

H* (f) high-pass reconstruction filter
G (f) low-pass decomposition filter
G* (f) low-pass reconstruction filter
Up arrow with 2 upsampling by 2
Down arrow with 2 downsampling by 2

A1

G: Bank of Low Pass filters

G* (f)

A1

Frequency

H (f)

Xt

A2
L

Level 1
H

D2
L

D1

Xt = A1 + D1

Level 2
Xt = A2 + D1+ D2

Level 3

A3

D3

Xt = A3 + D1+ D2 + D3

Level N
Xt = AN + D1+ D2 + DN

Mallats Pyramidal Filtering Approach

3.5E+05

4.8E+03

2.5E+05

4.6E+03
4.4E+03

1.5E+05

2.0E+05
1.0E+05

4.2E+03
4.0E+03

5.0E+04

3.8E+03

0.0E+00

3.0E+06

-1.0E+02
-1.5E+02

1.5E+06
1.0E+06
5.0E+05
0.0E+00
3.0E+06
2.5E+06

1.5E+02

2.0E+06

5.0E+01

1.5E+06

-5.0E+01

5.0E+05

1.0E+06

-1.5E+02
8.9E+01

FFT (2)

Level - 2

2.5E+02

2.0E+06

FFT (3)

-5.0E+01

2.5E+06

0.0E+00
3.5E+05
3.0E+05

3.9E+01
-1.1E+01
-6.1E+01
-1.1E+02

2.5E+05
2.0E+05
1.5E+05
1.0E+05
5.0E+04
0.0E+00

FFT (1)

Level - 3

0.0E+00

Fourier Power Spectrum

3.0E+05

FFT (FTSE)

5.2E+03
5.0E+03

5.0E+01

Level - 1

Wavelet Decompositions

FTSE 100

Wavelet Multiscale Analysis

Analyzing High-frequency
Financial Data: Our Approach

Tick Data

Preprocessing

Transformation

Knowledge
Discovery

Forecast

Data
Compression

Multiscale
Analysis

Summarization

Prediction

Aggregate the
movement in the
dataset over a
certain
period of time

Use the DWT

to deconstruct
the series

Describe market
dynamics at
different scales
(time horizons)
with
chief features

Use the
extracted
chief features
to predict

Cycle
Trend
Turning Points
Variance Change

Analyzing High-frequency
Financial Data: Our Approach
Generalized Algorithm: Summarization
I.

Compress the tick data to get Open (O), High (H), Low (L) and Close (C)
value for a given compression period (for example, one minute or five
minutes).

II.

Calculate the level L of the DWT needed based on number of samples N in

C of Step I,
L = floor [log (N)/log (2)].

III.

Perform a level-L DWT on C based on results of Step I and Step II to get,

Di, i = 1, . . ., L, and AL.

III-1.

Compute trend by performing linear regression on AL.

III-2.

Extract cycle (seasonality) by performing a Fourier power spectrum analysis

on each Di and choosing the Di with maximum power as DS.

III-3.

Extract turning points by choosing extremas of each Di.

IV.

Locate a single variance change in the series by using the NCSS index on
C.

V.

Generate a graphical and verbal summary for results of Steps III-1 to III-3
and IV.

Analyzing High-frequency
Financial Data: Our Approach
Generalized Algorithm: Prediction
I.

Summarize the tick data using the time series summarization algorithm.

II.

For a N-step ahead forecast, extend the seasonal component DS

symmetrically N points to the right to get DS, forecast.

III.

For a N-step ahead forecast, extend the trend component AN linearly N

points to the right to get AN, forecast.

IV.

Add the results of Steps II and III to get an aggregate N-step ahead forecast,
forecast
Forecast = DS, forecast + AN, forecast.

Analyzing High-frequency
Financial Data: Our Approach
A prototype system has been implemented that automatically
extracts chief features from a time series and give a prediction
based on the extracted features, namely trend and seasonality
Raw Signal

Volatility

NCSS

Detect
Variance
Change

Prediction

Statistic

FFT

Detect
Inherent
Cycles

Summarization

DWT

DWT

Detect
Turning
Points and
Trends

Analyzing High-frequency
Financial Data: Our Approach
A Case Study
Consider the five minutes compressed tick data for the /$ exchange rate on March 18, 2004
1.0
0.8

Input Data

0.6
1.84

0.4
0.2
0.0
0

25

50

75 100 125 150 175 200 225 250 275

1.83
Feature

1.82
Trend

1.82
0

25

50

75

100

125

150

175

200

225

250

275

Turning
Points
Variance
Change
Cycle

Phrases

Details

1st Phase

x1Trend 6.36e - 5 t + 1.81, t < 260

2nd Phase

xTrend
3.65e - 6 t + 1.83, 261 < t < 288
2

Downturns

108, 132, 164, and 178

Upturns

5,12,2036,68,and201

Location

164

Period

42

Peaks at

21, 54, 117, 181, 215, and 278

System Output

1.83

Analyzing High-frequency
Financial Data: Our Approach
A Case Study
For prediction,
prediction we use the chief features of the previous day (March 18, 2004), information about the
dominant cycle and trend (summarization), to reproduce the elements of the series for the following
day (March 19, 2004):
Actual
March 19, 2004

1.83
1.83
1.83

Predicted
(seasonal + trend)
March 19, 2004

1.82
1.82
0

25

50

75

100

125

150

175

System Output

Root Means Square Error = 0.0000381

Correlation = + 62.4 %

200

225

250

Analyzing High-frequency
Financial Data: Our Approach
Conclusions
I.

We have presented a time series summarization, annotation, and prediction

framework based on the multiscale wavelet analysis to deal with nonstationary,
volatile and high frequency financial data

II.

Multiscale analysis can effectively deconstruct the total series into its constituent
time scales: specific forecasting techniques can be applied to each timescale series
to gain efficiency in forecast

III.

Results of experiments performed on Intraday exchange data show promise for

summarizing and predicting highly volatile time series

IV.

Continuously evolving and randomly shocked economic systems demand for a

more rigorous and extended analysis,
analysis which is being planned

V.

Successful analysis of agents operating on several scales simultaneously and of

modeling these components could result in more exact forecasts

Questions / Comments