Data vs. information: Using clustering techniques to enhance stock returns forecasting

• Published in: International review of financial analysis 2023-07, Vol.88, p.102657, Article 102657
• Main Authors: Vásquez Sáenz, Javier, Quiroga, Facundo Manuel, Bariviera, Aurelio F.
• Format: Article
• Language: English
• Subjects: Clustering; Deep learning; Financial Reports; Investment algorithms; Stock price forecast; Trading
• ISSN: 1057-5219; 1873-8079
• DOI: 10.1016/j.irfa.2023.102657

This paper explores the use of clustering models of stocks to improve both (a) the prediction of stock prices and (b) the returns of trading algorithms. We cluster stocks using k-means and several alternative distance metrics, using as features quarterly financial ratios, prices and daily returns. Then, for each cluster, we train ARIMA and LSTM forecasting models to predict the daily price of each stock in the cluster. Finally, we employ the clustering-empowered forecasting models to analyze the returns of different trading algorithms. We obtain three key results: (i) LSTM models outperform ARIMA and benchmark models, obtaining positive investment returns in several scenarios; (ii) forecasting is improved by using the additional information provided by the clustering methods, therefore selecting relevant data is an important preprocessing task in the forecasting process; (iii) using information from the whole sample of stocks deteriorates the forecasting ability of LSTM models. These results have been validated using data of 240 companies of the Russell 3000 index spanning 2017 to 2022, training and testing with different subperiods. •Stock prediction and investing algorithm on stocks from the Russell 3000 index.•Training models with clustered data improves the prediction of stock prices.•Clustering of stocks is improved by including quarterly financial ratios.•Neural Network based models produce better returns than benchmark models.