Using candlesticks for Stock price direction prediction

Question

I am working on a college project wherein I want my machine learning model to predict the one-day-ahead direction of a given stock (i.e. whether the closing price of the stock would rise or fall as compared to previous day's closing price).

I am currently working on feature generation/extraction. In stock price direction prediction literature, the use technical indicators has been extensively studied. But I could not find much literature on the use of price action (candlestick patterns, to be specific) for prediction. So I want to implement candlestick patterns along with technical indicators to predict the direction. I generated some candle patterns from my data and assigned them scores.

The scores were assigned as follows:

If r denotes the no. of times the price moved in the direction indicated by the pattern and w denotes the no. of times the price moved in the opposite direction then, score = r/(r + w)

Now this is where I am confused and unsure about my approach. Some patterns obtained scores around 50% or less. Would these really help the model in predicting better? Or should I just drop the idea of using candlesticks and get on with technical indicators only?

Any advice or help is highly appreciated. Thank you.

P.S: I had asked this question on Cross Validated Stack Exchange and was advised to post the question here.

Answer 1

The accuracy of a model is only 1 factor in determining usefulness. Aside from the accuracy, it would help to determine how you would implement it in a simulated trading environment and look into the performance further.

Aside from a hit ratio or accuracy, you should compute other metrics such as:

• The risk-reward ratio that your model realizes (not the theoretical one that you hope it will)
• The profit factor: gross profit divided by gross loss
• Average gain and average loss
• Your expectancy per trade: (avg gain x hit ratio) - (avg loss x (1-hit ratio))
• Breakeven ratio: 1 / (1 + avg win / avg lost)

There are other metrics, too, but they wind up having some redundancy. I'm sure you could find a ton if you do some searching or googling. The point is that a correct prediction 50% of the time could be profitable if it returns more than it risks. On the other hand, a model that hit's 80% of its trades but only returns 1 for every 10 it risks could be very unprofitable. You should make looking into other metrics a habit to be sure you aren't throwing away models that warrant further investigating or chasing models that aren't worth it.