Exploiting Distance-Based Structures in Data Using an Explainable AI for Stock Picking

Abstract

In principle, the fundamental data of companies may be used to select stocks with a high probability of either increasing or decreasing price. Many of the commonly known rules or used explanations for such a stock-picking process are too vague to be applied in concrete cases, and at the same time, it is challenging to analyze high-dimensional data with a low number of cases in order to derive data-driven and usable explanations. This work proposes an explainable AI (XAI) approach on the quarterly available fundamental data of companies traded on the German stock market. In the XAI, distance-based structures in data (DSD) that guide decision tree induction are identified. The leaves of the appropriately selected decision tree contain subsets of stocks and provide viable explanations that can be rated by a human. The prediction of the future price trends of specific stocks is made possible using the explanations and a rating. In each quarter, stock picking by DSD-XAI is based on understanding the explanations and has a higher success rate than arbitrary stock picking, a hybrid AI system, and a recent unsupervised decision tree called eUD3.5.