Professional Documents
Culture Documents
Forecasting
Forecasting
Forecasting
Predicted
demand
looking
Time back six
Jan Feb Mar Apr May Jun Jul Aug months
Actual demand (past sales)
Predicted demand
What’s Forecasting All About?
From the March 10, 2006 WSJ:
Sometimes models tuned to prior results don't have great predictive powers.
Some general characteristics of forecasts
• Trends
• Seasonality
• Cyclical elements
• Autocorrelation
• Random variation
Some Important Questions
1. Data availability
2. Time horizon for the forecast
3. Required accuracy
4. Required Resources
Time Series: Moving average
At + At-1 + … + At-n
Ft+1 =
n
Month Bottles
Jan 1,325
Feb 1,353
Mar 1,305 What will
the sales be
Apr 1,275
for July?
May 1,210
Jun 1,195
Jul ?
What if we use a 3-month simple moving average?
What do we observe?
1000
900
Demand
Demand
800
3-Week
700
6-Week
600
500
1 2 3 4 5 6 7 8 9 10 11 12
Week
Time series: weighted moving average
We may want to give more importance to some of the data…
wt + wt-1 + … + wt-n = 1
For a 6-month
SMA, attributing
equal weights to all
past data we miss
Time the downward trend
Jan Feb Mar Apr May Jun Jul Aug
Example: Kroger sales of bottled water
Month Bottles
Jan 1,325
Feb 1,353
What will
Mar 1,305
be the sales
Apr 1,275 for July?
May 1,210
Jun 1,195
Jul ?
6-month simple moving average…
Make the weights for the last three months more than the first
three months…
July
1,277 1,267 1,257 1,247
Forecast
Smoothin
g Denotes the importance
constant of the past error
alpha α
Why use exponential smoothing?
Jun ? 1,309
Example: bottled water at Kroger
Jun ? 1,225
Impact of the smoothing constant
1380
1360
1340
1320 Actual
1300
a = 0.2
1280
1260 a = 0.8
1240
1220
1200
0 1 2 3 4 5 6 7
Trend..
Sales
Actual
Regular exponential
Data smoothing will always
Forecast lag behind the trend.
Can we include trend
analysis in exponential
smoothing?
Month
Exponential smoothing with trend
FIT: Forecast including trend
FITt Ft Tt δ: Trend smoothing constant
At Ft Tt FITt α = 0.8
δ = 0.5
Jan 1325 1380 -10 1370
Feb 1353 1334 -28 1306
Mar 1305 1344 -9 1334
Apr 1275 1311 -21 1290
May 1210 1278 -27 1251
Jun 1218 -43 1175
Exponential Smoothing with Trend
1400
1350
Actual
1300
a = 0.2
1250 a = 0.8
a = 0.8, d = 0.5
1200
1150
0 1 2 3 4 5 6 7
Linear regression in forecasting
Alcohol Sales
Average Monthly
Temperature
The best line is the one that minimizes the error
Y a bX
εi yi - Yi
Min i
2
What does that mean?
Alcohol Sales ε ε
ε
So LSM tries to
minimize the distance
between the line and
the points!
Average Monthly
Temperature
Least Squares Method of Linear Regression
Y a bX
a y bx
b
xy nx y
x nx
2 2
How can we compare across forecasting models?
A F t t
MFE i 1
n
A F t t
MAD i1
n
On average, the
arrows hit the
bullseye (so much
for averages!)
MFE & MAD:
An Analogy
The forecasts
are inaccurate &
biased
Key Point
MAD TS
Exponential
70 - 6.0
Smoothing
Forecast
33 - 2.0
Including Trend