Hybridization of hidden markov model and case based reasoning for time series forecasting

In the past few years, tremendous studies have been made to examine the accuracy of time series forecasting that provide the foundation for decision models in foreign exchange data. This study proposes a novel approach of Hidden Markov Model and Case Based reasoning for time series forecasting. This paper compares the proposed method with the technical models; moving average convergence/divergence model (MACD), William's percent range, and naïve strategy for short-term trading decision. HMM is trained by using forwardbackward or Baum-Welch algorithm and the likelihood value is used to predict future exchange rate price. The forecasting accuracy has been measured according to Root Mean Square Error (RMSE). The statistical performance of all techniques is investigated in testing of EUR/USD exchange rate time series over the period of October 2010 to November 2013. The preliminary results indicate that the new approach of HMM produce the lowest RMSE compared to the benchmark models. Further study is to adopt Case Based reasoning to further improve the forecasting results. © 2014 The authors and IOS Press. All rights reserved.