Using Markov Chains in finance to predict stock market trajectories with mixed results

Markov chains, a statistical framework, are being used in finance to predict market trajectories. Two papers, “Stock market analysis with a Markovian approach” and “Forecasting Stock Prices using Markov Chains” analyzed this concept but yielded marginal results compared to a coin toss due to not capturing underlying context or sentiment regime.

To improve predictive accuracy, discretizing 10 weeks of price action into distinct behavioral states can better capture sustained behaviors, leading to more accurate predictions. By applying the spirit of the law rather than the letter, modified Markov chains optimized for the stock market can provide statistically compelling insights for investors.

In the case of Domino’s Pizza (DPZ) stock, a 3-7-D sequence indicates a negative trajectory over the past 10 weeks. When this sequence appears, the following week typically sees upside 61.54% of the time, with a median return of 2.93%. This pattern may signal potential opportunities for investors to consider specific options strategies, like the 460/470 bull call spread expiring July 18.

Akamai Technologies (AKAM) stock has dropped nearly 17% since the beginning of the year, with a recent 4-6-D sequence observed in the past 10 weeks. This sequence has historically resulted in upside price action in 61.76% of cases, with a median return of 2.65%. Speculators may explore options like the 81/82 bull spread for potential trades.

DocuSign (DOCU) stock, down over 12% since the start of the year, exhibited a rare 6-4-D sequence in the past 10 weeks. This pattern historically led to upside price action in 58.82% of cases, with a median return of 3.57%. Traders seeking high-risk, high-reward opportunities might consider the 81/83 bull spread expiring July 25.

Read more at Yahoo Finance: Using Markov Chains to Help Extract Profits From DPZ, AKAM and DOCU