The Alpha Scientist

Discovering alpha in the stock market using data science

Stock Prediction with ML: Feature Selection


This is the third post in my series on transforming data into alpha. If you haven't yet see the data management and guide to feature engineering, please take a minute to read those first...

This post is going to delve into the mechanics of feature selection to help choose between the many variations of features created in the feature engineering stage. If you'd like to replicate and experiment with the below code, you can download the source notebook for this post by right-clicking on the below button and choosing "save link as"

By design, many of the features you've created will be very similar to each other (aka "collinear") because you've derived them from the same underlying dataset. If we were to keep many highly collinear features in our dataset used to train models, it would likely cause the model to "learn" some very funky and dangerous patterns. I will discuss this in greater depth in a future post.

The goal of feature selection is to reduce our possible features into the best set of features to learn from data. This will lead to models which generalize better (i.e., work well on data they haven't seen). They will also be much more interpretable.


In feature selection, we strive to meet two goals:

  1. Strength: Choose the features with the strongest, most persistent relationships to the target outcome variable. The reasons for this are obvious.
  2. Orthogonality: Minimize the amount of overlap or collinearity in your selected features. The importance of orthogonality (non-overlap) of features is much greater than you might guess.

I am biased towards making feature selection a relatively mechanical process. The "art" should mainly be encapsulated within the prior step (feature engineering) and the subsequent step (modeling).

Feature selection should, in my view, follow a heuristic and can be encoded into an algorithm if desired. For purposes of this tutorial, I'll keep things relatively manual.

Preparing the data

Let's dive in. I will begin by loading prices and creating outcomes DataFrame as done in the post on data management.

In [1]:
## Replace this section of imports with your preferred
## data download/access interface.  This calls a 
## proprietary set of methods (ie they won't work for you)

from IPython.core.display import Image

import numpy as np
import pandas as pd
pd.core.common.is_list_like = pd.api.types.is_list_like # remove once updated pandas-datareader issue is fixed
import as web
%matplotlib inline

def get_symbols(symbols,data_source, begin_date=None,end_date=None):
    out = pd.DataFrame()
    for symbol in symbols:
        df = web.DataReader(symbol, data_source,begin_date, end_date)\
        df.columns = ['date','open','high','low','close','volume'] #my convention: always lowercase
        df['symbol'] = symbol # add a new column which contains the symbol so we can keep multiple symbols in the same dataframe
        df = df.set_index(['date','symbol'])
        out = pd.concat([out,df],axis=0) #stacks on top of previously collected data
    return out.sort_index()
prices = get_symbols(['AAPL','CSCO','AMZN','YHOO','MSFT'],data_source='quandl',begin_date='2012-01-01',end_date=None)

                      open      high      low    close      volume
date       symbol                                                 
2018-03-26 MSFT      90.61    94.000    90.40    93.78  55031149.0
2018-03-27 AAPL     173.68   175.150   166.92   168.34  38962839.0
           AMZN    1572.40  1575.960  1482.32  1497.05   6793279.0
           CSCO      44.49    44.520    42.24    42.68  30088447.0
           MSFT      94.94    95.139    88.51    89.47  53704562.0
In [2]:
outcomes = pd.DataFrame(index=prices.index)
# next day's opening change
outcomes['close_1'] = prices.groupby(level='symbol').close.pct_change(-1) # next day's returns
outcomes['close_5'] = prices.groupby(level='symbol').close.pct_change(-5) # next week's returns
outcomes['close_10'] = prices.groupby(level='symbol').close.pct_change(-10) # next two weeks' returns
outcomes['close_20'] = prices.groupby(level='symbol').close.pct_change(-20) # next month's (approx) returns

                    close_1  close_5  close_10  close_20
date       symbol                                       
2018-03-26 MSFT    0.048173      NaN       NaN       NaN
2018-03-27 AAPL         NaN      NaN       NaN       NaN
           AMZN         NaN      NaN       NaN       NaN
           CSCO         NaN      NaN       NaN       NaN
           MSFT         NaN      NaN       NaN       NaN

However, unlike the prior tutorials, we're going to engineer some features which are constructed to contain a relationship to the outcomes along with quite a bit of random noise. Clearly, this is not something we'd do in real usage but will help to demonstrate the concept more clearly.

Assume we have a target variable called outcome which can be (partially) predicted with three factors, factor_1, factor_2 and factor_3. There's also an unpredictble noise component.

We'll use numpy.random to graft dummy values mapped onto the indices of real price data.

In [3]:
num_obs = prices.close.count()
factor_1 = pd.Series(np.random.randn(num_obs),index=prices.index)
factor_2 = pd.Series(np.random.randn(num_obs),index=prices.index)
factor_3 = pd.Series(np.random.randn(num_obs),index=prices.index)
outcome = 1.*factor_1 + 2.*factor_2 + 3.*factor_3 + 5.*np.random.randn(num_obs) = 'outcome'
date        symbol
2018-03-26  MSFT      1.619244
2018-03-27  AAPL      0.669392
            AMZN     -7.372092
            CSCO     -0.209091
            MSFT     -8.924626
Name: outcome, dtype: float64

Now, we will engineer several variations on features which each contain some information about the three factors, plus a few which contain some interaction effects, and some which do not contain any useful data.

Note that we are, again, "cheating" here for illustration purposes.

In [4]:
features = pd.DataFrame(index=outcome.index)
features['f11'] = 0.2*factor_1 + 0.8*np.random.randn(num_obs)
features['f12'] = 0.4*factor_1 + 0.6*np.random.randn(num_obs)
features['f13'] = 0.6*factor_1 + 0.4*np.random.randn(num_obs)

features['f21'] = 0.2*factor_2 + 0.8*np.random.randn(num_obs)
features['f22'] = 0.4*factor_2 + 0.8*np.random.randn(num_obs)
features['f23'] = 0.6*factor_2 + 0.4*np.random.randn(num_obs)

features['f31'] = 0.2*factor_3 + 0.8*np.random.randn(num_obs)
features['f32'] = 0.4*factor_3 + 0.6*np.random.randn(num_obs)
features['f33'] = 0.6*factor_3 + 0.4*np.random.randn(num_obs)

features['f41'] = 0.2*factor_1+0.2*factor_2 + 0.6*np.random.randn(num_obs)
features['f42'] = 0.2*factor_2+0.2*factor_3 + 0.6*np.random.randn(num_obs)
features['f43'] = 0.2*factor_3+0.2*factor_1 + 0.6*np.random.randn(num_obs)

features['f51'] = np.random.randn(num_obs)
features['f52'] = np.random.randn(num_obs)
features['f53'] = np.random.randn(num_obs)

                        f11       f12       f13       f21       f22       f23  \
date       symbol                                                               
2018-03-26 MSFT   -0.041104  0.238372  0.413337 -0.478707 -0.248044  0.135140   
2018-03-27 AAPL    0.569879 -0.333113 -1.205543  1.506631  0.641764  0.047848   
           AMZN   -0.032226 -0.001385  0.411697 -0.213998 -1.078521 -0.745223   
           CSCO   -0.954817 -0.455529  0.759212  0.108211 -0.255423  0.865484   
           MSFT   -0.184980  0.028665 -0.363028 -0.701258  1.567036  0.677576   

                        f31       f32       f33       f41       f42       f43  \
date       symbol                                                               
2018-03-26 MSFT    0.308846  0.059778  0.269863  0.297112  0.211582 -0.375905   
2018-03-27 AAPL   -1.021095 -1.187441  1.198066 -0.227440 -0.051018  0.147372   
           AMZN   -1.366262 -0.869260 -1.096526  0.200837  0.097775 -0.100074   
           CSCO   -0.853482 -0.102179 -0.785770  0.165970 -0.259788  0.192491   
           MSFT    0.940413 -0.476567 -0.277618  0.218573 -0.052515  0.048862   

                        f51       f52       f53  
date       symbol                                
2018-03-26 MSFT   -0.160892  0.963626  0.039153  
2018-03-27 AAPL    0.549437 -0.418202  0.124258  
           AMZN   -0.120544 -0.996801  0.266643  
           CSCO    0.244743 -1.368344 -0.660723  
           MSFT    0.644907  0.176948  0.426277  

Before evaluating the features for predictive strength and orthogonality, we'll do a quick data preparation stage. It is sometimes vital to "standardize" or "normalize" data so that we get fair comparisons between features of differing scale. Strictly speaking, since all of the doctored outcome and feature data is already drawn from normal distribution (using the numpy function random.rnorm()) we don't really need this step, but good practice to include.

Here, I'll use the scikit-learn StandardScaler() method and some pandas magic to transform the data.

In [5]:
import seaborn as sns

import matplotlib.pyplot as plt
%matplotlib inline
from IPython.display import display

from scipy.cluster import hierarchy
from scipy.spatial import distance

from sklearn.preprocessing import StandardScaler,Normalizer

#f = features.dropna() #optional - to compare apples to apples

# standardize or normalize data 
std_scaler = StandardScaler()
features_scaled = std_scaler.fit_transform(features.dropna()) 
print (features_scaled.shape)
df = pd.DataFrame(features_scaled,index=features.dropna().index)
df.columns = features.dropna().columns

# standardize outcome as well 
outcome_df = outcome.to_frame()
outcome_scaled = std_scaler.fit_transform(outcome_df.dropna()) 
outcome_scaled = pd.DataFrame(outcome_scaled,index=outcome_df.dropna().index)
outcome_scaled.columns = outcome_df.columns
(7639, 15)
date       symbol          
2018-03-26 MSFT    0.252853
2018-03-27 AAPL    0.101434
           AMZN   -1.180483
           CSCO   -0.038608
           MSFT   -1.427977
In [6]:
corr = df.corrwith(outcome)
corr.sort_values().plot.barh(color = 'blue',title = 'Strength of Correlation')
<matplotlib.axes._subplots.AxesSubplot at 0xaa89908>

Pretend for a minute that we don't know which features are going to be stronger and weaker, and which are going to tend to cluster together. We've got an idea that there are some quite strong features, some weaker, and some useless.

While correlation is not the perfect metric, it gives us a reasonable sense of strength of each feature's historical relationship to the outcome variable.

However, it says nothing about orthogonality. To get an idea about this, we'll take advantage of the very handy seaborn clustermap chart type which plots a heatmap representation of a covariance matrix and runs a hierarchical clustering algorithm to group together the most closely related features.

In [7]:
corr_matrix = df.corr()
correlations_array = np.asarray(corr_matrix)

linkage = hierarchy.linkage(distance.pdist(correlations_array), \

g = sns.clustermap(corr_matrix,row_linkage=linkage,col_linkage=linkage,\
plt.setp(g.ax_heatmap.yaxis.get_majorticklabels(), rotation=0)

label_order = corr_matrix.iloc[:,g.dendrogram_row.reordered_ind].columns

The algorithm has done a good job of finding the groupings of features. Of course, the diagonal of dark green represents each feature being perfectly correlated with itself, but we also see certain clusters of features which are similar to one another.

The cluster in the upper left captures factor_1 (including some of the interaction effects). factor_3 is fairly well isolated in the lower right corner, and in the middle we can see factor_2 as well as some of the noise features.

Let's next focus in only on those features with correlations of greater than 0.1 to exclude the noise and weak features.

In [8]:
correlated_features = corr[corr>0.1].index.tolist()
corr_matrix = df[correlated_features].corr()
correlations_array = np.asarray(corr_matrix)

linkage = hierarchy.linkage(distance.pdist(correlations_array), \

g = sns.clustermap(corr_matrix,row_linkage=linkage,col_linkage=linkage,\
plt.setp(g.ax_heatmap.yaxis.get_majorticklabels(), rotation=0)

label_order = corr_matrix.iloc[:,g.dendrogram_row.reordered_ind].columns
print("Correlation Strength:")
Correlation Strength:
f33    0.421067
f32    0.270004
f23    0.258847
f42    0.241708
f43    0.191224
f41    0.145155
f22    0.136999
f13    0.125092
f31    0.104860
dtype: float64

Ah, now the clusters look a bit sharper. We'll follow a simple heuristic to manually select the features.

Step 1: Take the most strongly correlated feature (f33) and add it to our list of selected features. Step 2: Take the second correlated feature (f23) and check to see if it's closely correlated (neighboring in the clustermap) to any features already chosen. If no, add to the list. If yes, discard. Step 3: Repeat this process until either (1) we've reached the target feature count, or (2) we've run out strongly correlated features.

Those interested could encode this heuristic into an algorithm without too much difficulty.

Following this heuristic, I get the below features:

In [9]:
selected_features = ['f33','f23','f42','f41','f31']
import seaborn as sns
<seaborn.axisgrid.PairGrid at 0xc714470>

Note that this list of features is not simply the highest correlated features. Let's run the clustermap one more time to see if we've missed any major clusters.

In [10]:
corr_matrix = df[selected_features].corr()
correlations_array = np.asarray(corr_matrix)

linkage = hierarchy.linkage(distance.pdist(correlations_array), method='average')

g = sns.clustermap(corr_matrix,row_linkage=linkage,col_linkage=linkage,\
plt.setp(g.ax_heatmap.yaxis.get_majorticklabels(), rotation=0)

label_order = corr_matrix.iloc[:,g.dendrogram_row.reordered_ind].columns

Looks generally pretty good. There is some residual covariance between features, so we haven't achieved orthogonal nirvana, but we're pretty close.

Thus far, we've only used a simple correlation statistic across the full time period. This is a good place to start but, in my opinion, is a dangerous place to stop. Financial time series data suffers from non-stationarity and regime change, so a relationship which on average has existed may have been wildly unstable over time.

To check, we'll plot the rolling correlation of these selected features.

In [11]:
tmp = df[selected_features].join(outcome_scaled).reset_index().set_index('date')
tmp.dropna().resample('Q').apply(lambda x: x.corr()).iloc[:,-1].unstack()\
.iloc[:,:-1].plot(title='Correlation of Features to Outcome\n (by quarter)')
# shows time stability
<matplotlib.axes._subplots.AxesSubplot at 0xe67c1d0>

As expected, since the data wasn't modeled with any non-stationarity, our features all appear to be robust over time. This gives increased confidence that the relationship we've found is likely to persist.


This installment of the tutorial series has walked through a systematic approach for selecting a subset of features from a universe of many overlapping (collinear) features. At this point, we're ready to model!

In the next post, I'll walk through an approach for training models in a "walk forward" basis - highly useful when working with ordered (e.g., time series) datasets.

One last thing...

If you've found this post useful, please follow @data2alpha on twitter and forward to a friend or colleague who may also find this topic interesting.

Finally, take a minute to leave a comment below - either to discuss this post or to offer an idea for future posts. Thanks for reading!