A Comparison of GA-trained and Backpropagation-trained Artificial Neural
Networks for Discovery of Financial Trading Strategies
Andrew Skabar and Ian Cloete
School of Information Technology, International University in Germany
Bruchsal, D-76646, Germany
{andrew.skabar, ian.cloete}@i-u.de
Abstract
Several sources have suggested the use of neural networks for
predicting profitable buy and sell points for financial commodi-
ties traded on a stock exchange. In this paper we compare the
performance of two neural network traders—one trained using
backpropagation, the other trained indirectly using a genetic
algorithm based weight optimization procedure. Comparison of
results on Dow Jones Industrial Average index data shows that
the GA-trained network performs markedly better than the
backpropagation-trained network in making good buy and sell
decisions on test data. Comparison of the performance of the
traders on the Dow Jones data with performance on random
walk data lends support to the claim that the observed predict-
ability on the Dow Jones index is real and not anomalous.
Keywords
Neural networks, genetic algorithms, stock market
1. Introduction
Approaches to forecasting the future direction of share
market prices fall broadly into two categories—those that
rely on technical analysis, and those that rely on funda-
mental analysis. While technical analysis uses only his-
torical data (past prices, volume of trading, volatility, etc.)
to determine the movement in the price of some financial
asset, fundamental analysis is based on external informa-
tion; that is, information that comes from the economic
system surrounding the market. Such information in-
cludes interest rates, prices and returns of other assets,
and many other macro- or micro-economic variables. The
use of technical analysis goes against the grain of conser-
vative academic opinion, which regards this behaviour as
irrational given the efficient markets hypothesis (Malkiel
1996).
The efficient markets hypothesis asserts that the price
of an asset reflects all of the information that can be ob-
tained from past prices of the asset. The main argument
for the hypothesis is that any opportunity for a profit will
be exploited immediately, and hence disappear. That is,
the market is so efficient that no one can buy or sell
quickly enough to consistently benefit. A consequence of
this hypothesis is that stock prices follow a random walk
and are unpredictable based on any amount of historical
data. The most appropriate investment strategy is thus a
buy-and-hold strategy.
Despite the implications of the efficient markets hy-
pothesis, many traders continue to make buy and sell de-
cisions based on historical data. These decisions are made
under the premise that patterns exist in that data, and that
these patterns provide an indication of future movements.
If such patterns exist, then it is possible in principle to
apply automated pattern recognition techniques such as
neural networks to the discovery of these patterns.
Several sources have reported on the simulation of
trading agents based on Artificial Neural Networks
(ANNs) (White 1988; Kimoto et al 1990; Yoon & Swales
1991; Weigend & Gershenfeld 1994). While the tradi-
tional approach to supervised neural network weight op-
timization is the well-known backpropagation algorithm
(Rumelhart & McClelland 1986), Beltratti, Margarita and
Terna (1996) report on the use of genetic search for neural
network weight optimisation in this domain. One of the
advantages of genetic search as a weight-optimisation
technique is that it allows flexibility in the choice of crite-
ria that can be used as an objective function to guide
search through the space of weight configurations.
In this paper we compare the performance of two
neural network traders in predicting buy and sell points
for the Dow Jones Industrial Average Index over a period
of approximately three years. One of the neural traders is
trained using back-propagation, the other is trained indi-
rectly using a genetic algorithm based weight optimiza-
tion procedure. The architecture of the neural networks in
each case is identical. In order to test whether the predict-
ability that we observe on the Dow Jones data is real or
anomalous, we compare the performance of the neural
network traders on real data with their performance on
random walk data.
The paper is organized as follows. Section 2 outlines
how neural networks can be used to represent a financial
training strategy. Section 3 describes how back-
propagation can be used to train a network on financial
time series data, and Section 4 describes the use of ge-
netic search for weight optimisation. In Section 5 we pre-
sent empirical results on the performance of the traders.
Section 6 concludes the paper.
2. Neural Networks for Automated Trading
One approach to developing neural network trading mod-
els is to first train the neural network to predict the value
of the closing price of some asset one or more days into
the future. An entry/exit (i.e. buy or sell) decision can
then be made on the basis of this prediction. We take an
alternative approach that does not attempt exact numeric
prediction of the asset value, but rather attempts to recog-
nize patterns in the input data that can provide clues as to
the optimal points to make buy or sell decisions.
The neural buying and selling agent we use consists
of an input layer, one hidden layer of sigmoidally acti-
vated units, and a single sigmoidally activated output that
is thresholded such that output values above 0.5 are inter-
preted as a buy signal, and all other values are interpreted
as a signal to sell. These signals, in conjunction with the
particular trading strategy that is adopted, determines the
trading position.
In this paper, we adopt a one-point buying and selling
strategy. This means that all available capital is invested
in shares, or all capital is invested in some low-risk fixed
interest security. On the basis of the trading signal issued
by the network, either the low-risk security is sold and
shares are bought (buy signal), or vice-versa (sell signal).
The general approach is to first discover a set of net-
work weights representing a trading strategy that per-
forms well on a set of training data, and to then apply this
same trading strategy to a set of test data.
3. Backpropagation Training
The traditional approach to neural network weight opti-
mization is backpropagation training (Rumelhart &
McClelland 1986). This is a supervised training algorithm
that relies on the availability of a set of labelled training
data. Thus, in order to apply backpropagation training to
this problem domain, we require the training data to be
labelled with buy and sell decisions which result in good
performance over the data representing the training pe-
riod. How might one go about labeling the training data?
One approach to labeling the training data is to have
an expert label the data with optimal trading points. While
one difficulty with this is that experts will not necessarily
agree on what the optimum buy and sell points are, a
more profound concern is the interpretation of a neural
network trained on such expert assigned data. The expert
will undoubtedly use rules of thumb in assigning the
training labels, and any network trained on such data will
merely result in a neurally encoded (approximate) repre-
sentation of the decision strategy used by the expert.
To avoid these problems we automate the labeling of
data by assigning an example a buy target if a decision to
buy on the day represented by that example would have
resulted in a profit. Similarly, an example is assigned a
sell target if a decision to sell would have resulted in a
profit. In other words, all points in a downward trend are
labeled as sells, and all points in an upward trend are la-
beled as buys. Thus, assuming a one-point trading strat-
egy, trades will take place at every peak and trough.
The justification for this labeling procedure is that it
results in the best possible return that could have been
achieved on the training data given complete knowledge
of the future—no expert could have performed better.1
4. Genetic Algorithm Weight Optimization
An alternative approach to backpropagation is to discover
a set of network weights indirectly by using some crite-
rion to measure the performance of the trading decisions
made by the agent, and to use this measure to guide
search through the space of weight configurations. Ge-
netic algorithms are particularly suitable for this as they
allow complete flexibility in the choice of an objective
function to guide search.
Genetic algorithms (Goldberg 1989; Holland 1975)
have been extensively applied to complex parameter tun-
ing problems in which various parameters of a system
interact in unknown and non-linear ways resulting in a
complex, irregular response surface (Bäck and Schwefel
1993). They have also been applied to neural network
weight optimisation (Whitley 1995).
The performance of genetic algorithms relies funda-
mentally on the formulation of an objective function that
is able to evaluate the success of competing individuals in
solving the problem at hand. Since we wish to discover a
neural trading agent that is able to maximize returns, we
must formulate an objective function that determines the
return made by the agent over data representing the value
of the index over some period of time. The optimality of
the agent’s decisions can be measured in terms of the
monetary return in following the agent’s decisions.
Assuming that the investor has a choice of investing
her capital in either shares or a low-risk fixed interest se-
curity, the accumulation of wealth over a period of N days
can be expressed as:
∑ {[ δ ][ ] }
N
W N = W0 + t −1 rm ,t + (1 − δ t −1 ) r f × 1 − δ t'−1 c × Wt −1
t =1
where Wt is the total wealth at day t, rf is the return rate of
the fixed interest security calculated daily, rm,t = (It - It-1) /
It-1 is the market return at day t where It is the share price
at time t, δt-1 is a delta function which equals 1 if capital is
invested in shares at the completion of trading day t-1 and
0 otherwise, c is the commission rate on a trade, and δ t'−1
is a delta function which equals 1 if a trade occurs at the
end of day t-1 and 0 otherwise. Thus, the first factor ap-
pearing in the summation represents the daily return rate
that is applicable for the current day (i.e. the market return
rate or the fixed interest return rate), the second factor
provides an adjustment for the cost of transactions, and
1
In practice, one should factor in trading costs into the labelling
procedure. That is, the relative increase or decrease in the value
of the stock may not be sufficient to offset the cost of the trans-
action. We ignore transaction costs in the labelling procedure on
the grounds that the network will not be able to model the train-
ing data perfectly, and that small increases/decreases are not as
important as larger ones. That is, it is the larger in-
creases/decreases that are more important in regards to perform-
ance on future data.
the third factor is the wealth at the close of the previous sponding to a buy-and-hold strategy are respectively
day’s trading. The return at the end of the trading period 14.9% and –5.2%.
is just the change in wealth divided by the initial wealth Testing the traders over a longer period can be
i.e. r = (WN – W0) / W0 , and it is this quantity which we achieved using a moving windows approach in which the
wish to maximize. training/testing set windows are advanced by N days after
Genetic search proceeds as follows. A population of each training/testing cycle, where N is the number of days
individuals, each representing a distinct neural network, is in each test period. The results of applying this approach
generated. Each of these networks is evaluated by fol- over an 880 day test period (i.e. 22 training/testing cycles)
lowing its trading predictions over the period represented are shown in Figure 2 (the results in Figure 1 correspond
by a set of historical training data and determining the to the last of these 22 cycles).
return at the end of this period. The fitness of an individ-
200%
ual is measured directly as the return that it is able to GA -trained netwo rk
180%
achieve. Reproduction, crossover and mutation operators B ackpro pagatio n-trained netwo rk
160%
are then applied to produce a new generation, with fitter 140%
B est P o ssible
individuals having a greater likelihood of contributing 120%
B uy-and-ho ld
offspring to the next generation. This procedure is al- 100%
lowed to proceed until either a predetermined number of 80%
generations has been reached, or until there is no further 60%
increase in fitness. At the completion of search, the best 40%
network is used to make buy/sell decisions over a test 20%
period. 0%
-20%
590 640 690 740 790 840
5. Empirical Results t ra ding da ys

This section presents results of applying of the above (a)

techniques to predicting buy and sell points for the Dow 20%
Jones Industrial Average index.2 The experiments are GA -trained netwo rk
B ackpro pagatio n-trained netwo rk
based on daily close values of the index over a period 15%
B est P o ssible
from July 1996 to March 2001. In all experiments, the 10% B uy-and-ho ld
input variables used were Pt-1 (the closing price of the
index on the previous trading day), MA5, MA10, MA15, 5%
MA30, and MA60 (the 5, 10, 15, 30 and 60 day moving
averages), based on commonly suggested trading rules 0%

(LeBaron et al 1999). All input variables were scaled -5%

linearly to the interval [0,1]. The size of the training win-
dow was set at 250 days. The network trained on this data -10%
was then applied to a test window consisting of the next 840 850 860 870 880
t ra ding da ys
40 trading days. We assume a low-risk fixed interest rate
of 4.0% per annum compounded daily, and a trading cost (b)
of 0.1% per trade. Figure 1. Single training/testing cycle (a) 250 day training
Figure 1a compares the performance of the back- cycle. The GA-trained network represents a better trading
propagation- and GA-trained networks over one train- strategy than the backpropagation-trained network; (b) 40 day
ing/testing cycle. Also shown are the best possible return test cycle. The GA-trained network achieves a 4.8% return in
and the return resulting from a buy-and-hold strategy. comparison to a return of 1.1% for the backpropagation-trained
Over the 250 day training period (Figure 1a), the buy and network.
sell decisions made by the GA-trained trader achieve a
120% GA -trained netwo rk
return of 59.1%, in comparison to a return of 28.0% for B ackpro pagatio n-trained netwo rk
the backpropagation-trained trader. The best possible per- 100%
B uy-and-ho ld
formance over the 250 day period is 199.7%, while a buy- 80% Fixed Interest
and-hold strategy results in a return of –6.8% (i.e. a loss).
60%
Over the 40 day test period (Figure 1b), the GA-
trained network achieves a return of 4.8% in comparison 40%
with a return of 1.1% for the backpropagation-trained 20%
trader. The best possible return and the return corre-
0%

-20%
2 0 200 400 600 800
This presumes the existence of an investment product (e.g. a
t ra ding da ys
unit trust) which purchases according to the make-up of the
index (i.e. the investment fund manager invests in all thirty Figure 2. Performance of traders over an 880 day forecast period
companies representing the index). using 22 training/testing cycles. The GA-trained network
achieves a total return of 128% over the test period (26.6% per
annum average return). The backpropagation-trained network
achieves a return of 48.0% (11.9% per annum average return).

Over the 880 day period, the average yearly return
from following the decisions made by the GA-trained
agent is 127.6% (26.6% per annum average return), while
the return for the back-propagation-trained network is
only 48.0% (11.9% per annum average return). The buy-
hold-return over the 880 day period is 27.2% (7.1% per
annum average return). The number of trades made by the
two networks over the 880 day period are almost identi-
cal—52 for the GA-trained network, and 54 for the back-
propagation-trained network.
The relatively poor performance of the backpropaga-
tion-trained network can be attributed to its poor ability to
model the training data presented to it. This poor ability is
reflected in the relatively high mean square error on the
training data (approximately 0.25 on most 250 day train-
ing windows), and is due to the high frequency of trend
reversals, many of which occur after only a marginal rise
or fall in the value of the index.
There are at least two ways in which a better model
for the training data could have been achieved: (i) using a
more complex network architecture; (ii) filtering out the
high frequency, low amplitude, fluctuations. While in-
creasing the complexity of the network (i.e. increasing
number of hidden layer units) would result in a network
better able to model the training data, this would most
likely result in over-fitting and hence degraded generali-
zation ability. While filtering out the smaller high fre-
quency fluctuations in the training data would also result
in a better model, the problem here is that there does not
appear to be any objective means for deciding on a suit-
able filtering procedure, and the approach would be ad
hoc.
13000
12000
11000
10000
9000
8000
7000
6000
5000
0 200 400 600 800
Despite the fact that the backpropagation-trained
network models the training data poorly, it still appears to
make some good trading decisions when projected onto
future data, resulting in an overall return slightly better
than that of a buy-and-hold strategy. However, this return
is significantly lower than that achieved by the GA-
trained trader.
5.1 Performance on Random Walk Data
Discovery of a neural network trader is based on the as-
sumption that patterns that have occurred in the past pro-
vide an indication of future movements in the value of the
index. Thus, the technique implicitly assumes that
changes in the value of the index are not entirely random.
How might we determine whether the predictability that
we have observed in the Dow Jones Index data is real or
anomalous?
One way of testing this is to compare the perform-
ance on real data with performance on one or more sets of
random walk data. If performance on the random data is
found to be comparable with that on real data, then we
cannot claim to have discovered any real predictability.
Random walk data for the Dow Jones Index can be
simulated by taking the sequence of relative daily changes
in the index value, and randomizing this sequence tempo-
rally. That is, the same set of relative daily changes are
maintained, but the order in which these changes occur is
randomized. This means that the increase in the index
over the entire period will be identical for each time series
produced in this manner, thus reducing problems with
biases that can arise from long term upward or downward
trends.
13000
12000
11000
10000
9000
8000
7000
6000
5000
0 200 400 600 800

(a) (b)
13000 13000
12000 12000
11000 11000
10000 10000
9000 9000
8000 8000
7000 7000
6000 6000
5000 5000
0 200 400 600 800 0 200 400 600 800

(c) (d)

Figure 3. (a) Dow Jones Industrial Average index values, (b) – (d) Random walk time series produced by temporally randomizing the
daily relative changes in the Dow Jones Industrial Average index.
 Figure 3 shows the original Dow Jones Industrial In-
dex data (Figure 3a) and three time series (Figures 3b,c,d)
generated by randomizing the sequence of relative daily
changes as described above. Table 1 shows the average
yearly returns achieved by GA-trained and backpropaga-
tion-trained neural network traders on each of these da-
tasets.
Table 1. Avg. yearly returns of network traders on 4 datasets
Average yearly return
GA Backprop. Buy&Hold
Dow Jones 26.6% 11.9% 7.1%
Random_1 3.1% -4.5% 7.1%
Random_2 4.6% 0.6% 7.1%
Random_3 12.3% 9.4% 7.1%
Each of the network traders perform better than a
buy-and-hold strategy on the 3rd randomized dataset, but
worse than that of a buy-and-hold strategy on the other
random datasets. The GA-trained trader performs better
than the backpropagation-trained trader on each dataset.
Thus, while the network traders (in particular the
GA-trained trader) may be able to find a trading strategy
that operates well on a set of (randomized) training data,
this trading strategy is not able to satisfactorily predict
good buy and sell points when projected into the future.
We can thus draw the weak conclusion that the predict-
ability that we have observed in the daily movements of
the Dow Jones Index is not anomalous, but indicates some
regularity in the time series which can be exploited to
make future decisions.
6. Conclusions
The results reported in this paper illustrate that a genetic
algorithm-trained neural network trader performs signifi-
cantly better than a backpropagation-trained trader (with
identical architecture) in deciding on good buy and sell
points on test financial data. Comparison of the perform-
ance of the traders on real data with performance on ran-
dom walk data lends support to the claim that the predict-
ability observed on the Dow Jones index is real and not
anomalous.
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