{"id":191683,"date":"2023-06-08T10:17:25","date_gmt":"2023-06-08T14:17:25","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=191683"},"modified":"2023-06-08T10:17:46","modified_gmt":"2023-06-08T14:17:46","slug":"random-forest-algorithm-in-trading-using-python","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/ibkr-quant-news\/random-forest-algorithm-in-trading-using-python\/","title":{"rendered":"Random Forest Algorithm In Trading Using Python"},"content":{"rendered":"\n<p><em>Excerpt<\/em><\/p>\n\n\n\n<p>In this blog, we\u2019ll discuss what are Random Forests, how do they work, how they help in overcoming the limitations of decision trees.<\/p>\n\n\n\n<p>With the boom of&nbsp;<a href=\"https:\/\/blog.quantinsti.com\/machine-learning-basics\" target=\"_blank\" rel=\"noreferrer noopener\">Machine Learning<\/a>&nbsp;and its techniques in the current environment, more and more of its algorithms find applications in various domains. The functions and working of machine learning algorithms differ from each other wherein one algorithm may be better for a certain problem than another one. Machine Learning algorithms are constantly updated and upgraded to widen its range of applications and to minimize its shortcomings.<\/p>\n\n\n\n<p>Random Forest algorithm is one such algorithm designed to overcome the limitations of Decision Trees.<\/p>\n\n\n\n<p>In this blog, we will be covering:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>What are Decision Trees?<\/li>\n\n\n\n<li>What is a Random Forest?<\/li>\n\n\n\n<li>Working of Random Forest<\/li>\n\n\n\n<li>Python Code for Random Forest<\/li>\n\n\n\n<li>Advantages and Disadvantages of Random Forest<\/li>\n<\/ul>\n\n\n\n<p>Before jumping directly to Random Forests, let\u2019s first get a brief idea about decision trees and how they work.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-what-are-decision-trees\"><strong>What are Decision Trees?<\/strong><\/h3>\n\n\n\n<p><a href=\"https:\/\/blog.quantinsti.com\/use-decision-trees-machine-learning-predict-stock-movements\" target=\"_blank\" rel=\"noreferrer noopener\">Decision trees<\/a>, just as the name suggests, have a hierarchical or tree-like structure with branches which act as nodes. We can arrive at a certain decision by traversing through these nodes which are based on the responses garnered from to the parameters related to the nodes.<\/p>\n\n\n\n<p>However, decision trees suffer from a problem of overfitting.&nbsp;<a href=\"https:\/\/quantra.quantinsti.com\/glossary\/Overfitting\" target=\"_blank\" rel=\"noreferrer noopener\">Overfitting<\/a>&nbsp;is basically increasing the specificity within the tree to reach to a certain conclusion by adding more and more nodes in the tree thus increasing the depth of the tree and making it more complex.<\/p>\n\n\n\n<p>Further, in this blog, we will understand how Random Forest helps to overcome this drawback of decision trees.<br><br>Learn&nbsp;<a target=\"_blank\" href=\"https:\/\/quantra.quantinsti.com\/course\/decision-trees-analysis-trading-ernest-chan\" rel=\"noreferrer noopener\">how to make a decision tree<\/a>&nbsp;to predict the markets and find trading opportunities using AI techniques with our Quantra course.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-what-is-a-random-forest\"><strong>What is a&nbsp;Random&nbsp;Forest?<\/strong><\/h3>\n\n\n\n<p>Random forest is a supervised classification machine learning algorithm which uses ensemble method. Simply put, a random forest is made up of numerous decision trees and helps to tackle the problem of overfitting in decision trees. These decision trees are randomly constructed by selecting random features from the given dataset.<\/p>\n\n\n\n<p>Random forest arrives at a decision or prediction based on the maximum number of votes received from the decision trees. The outcome which is arrived at, for a maximum number of times through the numerous decision trees is considered as the final outcome by the random forest.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-working-of-random-forest\"><strong>Working of Random Forest<\/strong><\/h3>\n\n\n\n<p>Random forests are based on ensemble learning techniques. Ensemble, simply means a group or a collection, which in this case, is a collection of decision trees, together called as random forest. The accuracy of ensemble models is better than the accuracy of individual models due to the fact that it compiles the results from the individual models and provides a final outcome.<\/p>\n\n\n\n<p>How to select features from the dataset to construct decision trees for the Random Forest?<\/p>\n\n\n\n<p>Features are selected randomly using a method known as bootstrap aggregating or bagging. From the set of features available in the dataset, a number of training subsets are created by choosing random features with replacement. What this means is that one feature may be repeated in different training subsets at the same time.<\/p>\n\n\n\n<p>For example, if a dataset contains 20 features and subsets of 5 features are to be selected to construct different decision trees then these 5 features will be selected randomly and any feature can be a part of more than one subset. This ensures randomness, making the correlation between the trees less, thus overcoming the problem of overfitting.<\/p>\n\n\n\n<p>Once the features are selected, the trees are constructed based on the best split. Each tree gives an output which is considered as a \u2018vote\u2019 from that tree to the given output. The output<\/p>\n\n\n\n<p>which receives the maximum \u2018votes\u2019 is chosen by the random forest as the final output\/result or in case of continuous variables, the average of all the outputs is considered as the final output.<\/p>\n\n\n\n<figure class=\"wp-block-image size-large\"><img decoding=\"async\" width=\"1100\" height=\"619\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Random-Forest-Algorithm-quantinsti-1100x619.jpg\" alt=\"\" class=\"wp-image-191687 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Random-Forest-Algorithm-quantinsti-1100x619.jpg 1100w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Random-Forest-Algorithm-quantinsti-700x394.jpg 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Random-Forest-Algorithm-quantinsti-300x169.jpg 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Random-Forest-Algorithm-quantinsti-768x432.jpg 768w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Random-Forest-Algorithm-quantinsti-1536x864.jpg 1536w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Random-Forest-Algorithm-quantinsti.jpg 1920w\" data-sizes=\"(max-width: 1100px) 100vw, 1100px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 1100px; aspect-ratio: 1100\/619;\" \/><\/figure>\n\n\n\n<p>For example, in the above diagram, we can observe that each decision tree has voted or predicted a specific class. The final output or class selected by the Random Forest will be the Class N, as it has majority votes or is the predicted output by two out of the four decision trees.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Python Code For Random Forest<\/strong><\/h3>\n\n\n\n<p>In this code, we will be creating a Random Forest Classifier and train it to give the daily returns.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\" id=\"Importing-the-libraries\">Importing the libraries<\/h4>\n\n\n\n<p>In&nbsp;[&nbsp;]:<\/p>\n\n\n\n<pre class=\"EnlighterJSRAW\" data-enlighter-language=\"generic\" data-enlighter-theme=\"\" data-enlighter-highlight=\"\" data-enlighter-linenumbers=\"\" data-enlighter-lineoffset=\"\" data-enlighter-title=\"\" data-enlighter-group=\"\">import quantrautil as q\nimport numpy as np\nfrom sklearn.ensemble import RandomForestClassifier<\/pre>\n\n\n\n<p>The libraries imported above will be used as follows:<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><a href=\"https:\/\/github.com\/QuantInsti\/Quantra-Courses\/blob\/master\/quantrautil.py\">quantrautil<\/a>&nbsp;&#8211; this will be used to fetch the price data of the BAC stock from yahoo finance.<\/li>\n\n\n\n<li>numpy &#8211; to perform the data manipulation on BAC stock price to compute the input features and output. If you want to read more about numpy then it can be found&nbsp;<a href=\"https:\/\/www.numpy.org\/\">here<\/a>.<\/li>\n\n\n\n<li>sklearn &#8211; Sklearn has a lot of tools and implementation of&nbsp;<a target=\"_blank\" href=\"https:\/\/blog.quantinsti.com\/trading-using-machine-learning-python\/\" rel=\"noreferrer noopener\">machine learning<\/a>&nbsp;models. RandomForestClassifier will be used to create Random Forest classifier model.<\/li>\n<\/ol>\n\n\n\n<h4 class=\"wp-block-heading\" id=\"Fetching-the-data\">Fetching the data<\/h4>\n\n\n\n<p>The next step is to import the price data of BAC stock from quantrautil. The get_data function from&nbsp;<a href=\"https:\/\/github.com\/QuantInsti\/Quantra-Courses\/blob\/master\/quantrautil.py\">quantrautil<\/a>&nbsp;is used to get the BAC data for 19 years from 1 Jan 2000 to 31 Jan 2019 as shown below. The data is stored in the dataframe&nbsp;data.<\/p>\n\n\n\n<p>In&nbsp;[2]:<\/p>\n\n\n\n<pre class=\"EnlighterJSRAW\" data-enlighter-language=\"generic\" data-enlighter-theme=\"\" data-enlighter-highlight=\"\" data-enlighter-linenumbers=\"\" data-enlighter-lineoffset=\"\" data-enlighter-title=\"\" data-enlighter-group=\"\">data = q.get_data('BAC','2000-1-1','2019-2-1')\nprint(data.tail())<\/pre>\n\n\n\n<pre class=\"EnlighterJSRAW\" data-enlighter-language=\"generic\" data-enlighter-theme=\"\" data-enlighter-highlight=\"\" data-enlighter-linenumbers=\"\" data-enlighter-lineoffset=\"\" data-enlighter-title=\"\" data-enlighter-group=\"\">[*********************100%***********************]  1 of 1 downloaded\n                 Open       High        Low      Close  Adj Close     Volume  \\\nDate                                                                           \n2019-01-25  29.280001  29.719999  29.139999  29.580000  29.580000   72182100   \n2019-01-28  29.320000  29.670000  29.290001  29.629999  29.629999   59963800   \n2019-01-29  29.540001  29.700001  29.340000  29.389999  29.389999   51451900   \n2019-01-30  29.420000  29.469999  28.950001  29.070000  29.070000   66475800   \n2019-01-31  28.750000  28.840000  27.980000  28.469999  28.469999  100201200   \n\n           Source  \nDate               \n2019-01-25  Yahoo  \n2019-01-28  Yahoo  \n2019-01-29  Yahoo  \n2019-01-30  Yahoo  \n2019-01-31  Yahoo<\/pre>\n\n\n\n<h4 class=\"wp-block-heading\" id=\"Creating-input-and-output-dataset\">Creating input and output dataset<\/h4>\n\n\n\n<p>In this step, I will create the input and output variable.<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li>Input variable: I have used &#8216;(Open &#8211; Close)\/Open&#8217;, &#8216;(High &#8211; Low)\/Low&#8217;, standard deviation of last 5 days returns (std_5), and average of last 5 days returns (ret_5)<\/li>\n\n\n\n<li>Output variable: If tomorrow\u2019s close price is greater than today&#8217;s close price then the output variable is set to 1 and otherwise set to -1. 1 indicates to buy the stock and -1 indicates to sell the stock.<\/li>\n<\/ol>\n\n\n\n<p>The choice of these features as input and output is completely random. If you are interested to learn more about feature selection then you can read&nbsp;<a href=\"https:\/\/en.wikipedia.org\/wiki\/Feature_selection\">here<\/a>.<\/p>\n\n\n\n<p>In&nbsp;[3]:<\/p>\n\n\n\n<pre class=\"EnlighterJSRAW\" data-enlighter-language=\"generic\" data-enlighter-theme=\"\" data-enlighter-highlight=\"\" data-enlighter-linenumbers=\"\" data-enlighter-lineoffset=\"\" data-enlighter-title=\"\" data-enlighter-group=\"\"># Features construction \ndata['Open-Close'] = (data.Open - data.Close)\/data.Open\ndata['High-Low'] = (data.High - data.Low)\/data.Low\ndata['percent_change'] = data['Adj Close'].pct_change()\ndata['std_5'] = data['percent_change'].rolling(5).std()\ndata['ret_5'] = data['percent_change'].rolling(5).mean()\ndata.dropna(inplace=True)\n\n# X is the input variable\nX = data[['Open-Close', 'High-Low', 'std_5', 'ret_5']]\n\n# Y is the target or output variable\ny = np.where(data['Adj Close'].shift(-1) > data['Adj Close'], 1, -1)<\/pre>\n\n\n\n<p>In&nbsp;[4]:<\/p>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>Train Test Split<\/strong><\/h4>\n\n\n\n<p>We now split the dataset into 75% Training dataset and 25% for Testing dataset.<\/p>\n\n\n\n<pre class=\"EnlighterJSRAW\" data-enlighter-language=\"generic\" data-enlighter-theme=\"\" data-enlighter-highlight=\"\" data-enlighter-linenumbers=\"\" data-enlighter-lineoffset=\"\" data-enlighter-title=\"\" data-enlighter-group=\"\"># Total dataset length\ndataset_length = data.shape[0]\n\n# Training dataset length\nsplit = int(dataset_length * 0.75)\nsplit<\/pre>\n\n\n\n<p>Out[4]:<\/p>\n\n\n\n<pre class=\"EnlighterJSRAW\" data-enlighter-language=\"generic\" data-enlighter-theme=\"\" data-enlighter-highlight=\"\" data-enlighter-linenumbers=\"\" data-enlighter-lineoffset=\"\" data-enlighter-title=\"\" data-enlighter-group=\"\">3597<\/pre>\n\n\n\n<p>In&nbsp;[5]:<\/p>\n\n\n\n<pre class=\"EnlighterJSRAW\" data-enlighter-language=\"generic\" data-enlighter-theme=\"\" data-enlighter-highlight=\"\" data-enlighter-linenumbers=\"\" data-enlighter-lineoffset=\"\" data-enlighter-title=\"\" data-enlighter-group=\"\"># Splitiing the X and y into train and test datasets\nX_train, X_test = X[:split], X[split:]\ny_train, y_test = y[:split], y[split:]\n\n# Print the size of the train and test dataset\nprint(X_train.shape, X_test.shape)\nprint(y_train.shape, y_test.shape)<\/pre>\n\n\n\n<pre class=\"EnlighterJSRAW\" data-enlighter-language=\"generic\" data-enlighter-theme=\"\" data-enlighter-highlight=\"\" data-enlighter-linenumbers=\"\" data-enlighter-lineoffset=\"\" data-enlighter-title=\"\" data-enlighter-group=\"\">(3597, 4) (1199, 4)\n(3597,) (1199,)<\/pre>\n\n\n\n<p><em>Originally posted on <a href=\"https:\/\/blog.quantinsti.com\/random-forest-algorithm-in-python\/\">QuantInsti<\/a> Blog.<\/em> <em>Visit their website to read more on this topic.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"<p>The functions and working of machine learning algorithms differ from each other wherein one algorithm may be better for a certain problem than another one. <\/p>\n","protected":false},"author":93,"featured_media":185953,"comment_status":"open","ping_status":"closed","sticky":true,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[339,343,349,338,341],"tags":[851,806,9634,1225,595,15398,9963,6810],"contributors-categories":[13654],"class_list":{"0":"post-191683","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-data-science","8":"category-programing-languages","9":"category-python-development","10":"category-ibkr-quant-news","11":"category-quant-development","12":"tag-algo-trading","13":"tag-data-science","14":"tag-decision-trees","15":"tag-numpy","16":"tag-python","17":"tag-quantrautil","18":"tag-random-forest","19":"tag-sklearn","20":"contributors-categories-quantinsti"},"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This site is optimized with the Yoast 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