Chapter 2

Data Patterns and Choice of

Forecasting Techniques
Trang, Ha Thi Thu (PhD)
SEM, HUST
CHAPTER 2

2.1. Data Patterns

2.2. Forecasting Methodologies

2.3. Technique Selection

2.4. Model Evaluation

“He who sees the past as surprise-free is bound to
have a future full of surprises.”
(Amos Tversky)
Data Pattern and Choice of Technique

The pattern of data

The nature of the past relationship in the data

The level of subjectivity in making a forecast

 All of the above help us in how we classify the

forecasting technique.
Data Pattern and Choice of Technique

Univariate forecasting techniques depend on:

-- Past data patterns.

Multivariate forecasting techniques depend on

-- Past relationships.

Qualitative forecasts depend on:

--- Subjectivity: Forecasters intuition.
2.1. Data Pattern

Data Patterns

 Simple observation of the data will show the way that

data have behaved over time.

 Data pattern may suggest the existence of a

relationship between two or more variables.

 Four Patterns: Horizontal, Trend, Seasonal, Cyclical.

2.1. Data Pattern

Two types of data:

 Cross-sectional data
Data collected at a single point in time, be it an hour, a
day, a week, a month, or a quarter.
The objective is to examine such data and then to
extrapolate or extend the revealed relationships to the
larger population.
 Time series data:
A time series consists of data that are collected,
recorded, or observed over successive increments of
time.
 Four Patterns: Horizontal, Trend, Seasonal, Cyclical.
2.1. Data Pattern

Four Patterns: Horizontal, Trend, Seasonal, Cyclical.

Horizontal
When there is no trend in the data pattern, we deal
with horizontal data pattern.
Forecast Variable

Mean

Time
2.1. Data Pattern

Trend
the long-term component that represents the growth
or decline in the time series over an extended period
of time.
Trend Yt Trend
Yt

t t

Yt Trend Yt
Trend

t t
2.1. Data Pattern

Cyclical
• Observations
exhibit rises and
falls that are not
of a fixed period
• Occurs with
business and
economic
expansions and
contractions.
• Lasts longer
than 1 year.
• Correlated with
business cycles.
2.1. Data Pattern

Seasonal Pattern
A predictable
and repetitive
movement
observed around
a trend line
within a period
of 1 year or less.
2.1. Data Pattern
Seasonal Pattern
2.1. Data Pattern

Differences between seasonal and cyclic patterns:

• Seasonal pattern constant length; cyclic pattern variable
length
• Average length of cycle longer than length of seasonal
pattern
• Magnitude of cycle more variable than magnitude of
seasonal pattern

The timing of peaks and troughs is predictable with seasonal

data, but unpredictable in the long term with cyclic data.
2.1. Data Pattern

The monthly housing sales show strong seasonality within each year, as
well as some strong cyclic behaviour with a period of about 6–10 years.
There is no apparent trend in the data over this period
2.1. Data Pattern

The US treasury bill contracts show results from the Chicago market for 100 consecutive
trading days in 1981.
There is no seasonality, but an obvious downward trend.
Possibly, if we had a much longer series, we would see that this downward trend is
actually part of a long cycle, but when viewed over only 100 days it appears to be a
trend.
2.1. Data Pattern

The Australian monthly electricity production shows a strong increasing

trend, with strong seasonality.
There is no evidence of any cyclic behaviour here.
2.1. Data Pattern

The daily change in the Google closing stock price has no trend, seasonality or
cyclic behaviour.
There are random fluctuations which do not appear to be very predictable, and
no strong patterns that would help with developing a forecasting model.
2.1. Data Pattern

Question 1. Indicate whether each of the

following statements describes a stationary or a
nonstationary series.
a. A series that has a trend
b. A series whose mean and variance remain
constant over time
c. A series whose mean value is changing over time
d. A series that contains no growth or decline
2.1. Data Pattern

Autocorrelated Pattern
• Data in one period are related to their values in the
previous period.
• Generally, if there is a high positive autocorrelation,
the value in the month of June, for example, is
positively related to the values in the month of
May.
• This pattern is more fully discussed when we talk
about the Box–Jenkins methodology.
2.1. Data Pattern

Autocorrelated Pattern
2.1. Data Pattern

Autocorrelated Pattern
2.1. Data Pattern

Autocorrelated Pattern
 Covariance and correlation: measure extent of linear
relationship between two variables (y and x).
 Autocovariance and autocorrelation: measure linear
relationship between lagged values of a time series
y.
We measure the relationship between:
 yt and yt−1
 yt and yt−2
 yt and yt−3
 etc.
2.1. Data Pattern

Artwork by @allison_horst
2.1. Data Pattern

Artwork by @allison_horst
2.1. Data Pattern

Artwork by @allison_horst
2.1. Data Pattern

Artwork by @allison_horst
2.1. Data Pattern

Artwork by @allison_horst
2.1. Data Pattern

Artwork by @allison_horst
2.1. Data Pattern

Artwork by @allison_horst
2.1. Data Pattern

Artwork by @allison_horst
2.1. Data Pattern

Artwork by @allison_horst
2.1. Data Pattern

Autocorrelated Pattern
The correlogram or autocorrelation function is a graph of the
autocorrelations for various lags of a time series.
2.1. Data Pattern

Autocorrelated Pattern
Autocorrelation coefficients for different time lags for a
variable can be used to answer the following questions about
a time series:
1. Are the data random?
2. Do the data have a trend (nonstationary)?
3. Are the data seasonal?
4. Are the data stationary?
2.1. Data Pattern

Autocorrelated Pattern
1. Are the data random?
• If a series is random, the autocorrelations between Yt and
Yt-k for any time lag k are close to zero.
• The successive values of a time series are not related to
each other
2.1. Data Pattern

Autocorrelated Pattern
2. Do the data have a trend (nonstationary)?
• If a series has a trend, successive observations are highly
correlated.
• rk typically are significantly different from zero for the first several
time lags
• rk gradually drop toward zero as the number of lags k increases
2.1. Data Pattern

Autocorrelated Pattern
3. Are the data seasonal?
• If a series is seasonal, a pattern related to the calendar
repeats itself over a particular interval of time (usually a
year).
• Observations in the same position for different seasonal
periods tend to be related.
• If quarterly data with a seasonal pattern are analyzed, a significant
autocorrelation coefficient will appear at time lag 4.
• If monthly data are analyzed, a significant autocorrelation
coefficient will appear at time lag 12.
2.1. Data Pattern

Autocorrelated Pattern
Trend and seasonality in ACF plots
 When data have a trend, the autocorrelations for
small lags tend to be large and positive.
 When data are seasonal, the autocorrelations will
be larger at the seasonal lags (i.e., at multiples of
the seasonal frequency)
 When data are trended and seasonal, you see a
combination of these effects.
2.1. Data Pattern

Autocorrelated
Pattern
When data are seasonal,
the autocorrelations will be
larger at the seasonal lags
(i.e., at multiples of the
seasonal frequency)

• r4 higher than for the other lags. This is due to the seasonal pattern in the
data: the peaks tend to be 4 quarters apart and the troughs tend to be 2
quarters apart.
• r2 is more negative than for the other lags because troughs tend to be 2
quarters behind peaks
2.1. Data Pattern

Autocorrelated
Pattern
When data have a
trend, the
autocorrelations for
small lags tend to be
large and positive.
2.1. Data Pattern

Autocorrelated
Pattern
2.1. Data Pattern

Which is which?
2.1. Data Pattern

Autocorrelated Pattern
4. Are the data stationary?
• A stationary time series is one whose mean and variance remain
constant over time.
• Consequently, a stationary series that varies about a fixed level
(no growth or decline) over time.

White noise data is uncorrelated across time with zero

mean and constant variance.
(Technically, we require independence as well.)
2.1. Data Pattern

Autocorrelated Pattern
White noise data is uncorrelated across time with zero
mean and constant variance.

• Sampling distribution of rk for white noise data is asymptotically N(0,1/T).

• 95% of all rk for white noise must lie within±1.96/√T.
• If this is not the case, the series is probably not WN.
• Common to plot lines at ±1.96/√T when plotting ACF. These are the critical
values.
2.1. Data Pattern

Autocorrelated Pattern
2.1. Data Pattern

Autocorrelated Pattern
Monthly total number of pigs slaughtered in the state of
Victoria, Australia, from January 2014 through December
2018 (Source: Australian Bureau of Statistics.)

• ACF shows significant autocorrelation for lag 2 and 12.

• Indicate some slight seasonality.
• These show the series is not a white noise series.
2.1. Data Pattern

Question 2. Descriptions are provided for several types of series:

random, stationary, trending, and seasonal.
Identify the type of series that each describes.
a) The series has basic statistical properties, such as the mean and
variance, that remain constant over time.
b) The successive values of a time series are not related to each other.
c) A high relationship exists between each successive value of a series.
d) A significant autocorrelation coefficient appears at time lag 4 for
quarterly data.
e) The series contains no growth or decline.
f) The autocorrelation coefficients are typically significantly different
from zero for the first several time lags and then gradually decrease
toward zero as the number of lags increases
2.2. Measures of Accuracy in Forecasting

Error in Forecasting

et  Yt  Yˆt
• Measures the average error that can be expected
over time.
• The average error concept has some problems with it.
The positive and negative values cancel each other
out and the mean is very likely to be close to zero.
2.2. Measures of Accuracy in Forecasting

MAD measures forecast accuracy

by averaging the magnitudes of
the forecast errors

MSE penalizes large

forecasting errors

MAD, MSE, RMSE are all scale dependent.

2.2. Measures of Accuracy in Forecasting

• MAPE, MPE is scale independent but is only sensible if yt >> 0 for all i,
and y has a natural zero.
• MPE is used to determine whether a forecasting method is biased
(consistently forecasting low or high).
 If the forecasting approach is unbiased, MPE ~ 0.
 If the result is a large negative percentage, the forecasting
method is consistently overestimating.
 If the result is a large positive percentage, the forecasting method
is consistently underestimating.
2.2. Measures of Accuracy in Forecasting

The five measures of forecast accuracy just described are

used
 To compare the accuracy of two (or more) different
techniques.
 To measure a particular technique’s usefulness or
reliability.
 To help search for an optimal technique.
2.3. Technique Selection

Forecasting methodologies fall into three categories:

• Quantitative Models

• Qualitative Models

• Technological Approaches
2.3. Technique Selection

Quantitative Models
• Also known as statistical models.

• Include time series and regression approaches.

• Forecast future values entirely on the historical

observation of a variable.
2.3. Technique Selection

• Quantitative Models
• An example of a quantitative model is shown below:

Yt 1   0  1Yt   2Yt 1
Y t  1 = Sales one time period into the future
Yt = Sales in the current period
Yt 1 = Sales in the last period
2.3. Technique Selection

Qualitative Models
• Non-statistical or judgment models

• Expert opinion

• Executive opinion

• Sale force composite forecast

• Focus groups

• Delphi method
2.3. Technique Selection

Technological Approach
• Combines quantitative and qualitative methods.

• The objective of the model is to combine technological,

societal, political, and economic changes.
2.3. Technique Selection

Forecasters depend on:

• The characteristics of the decision-making situation which
may include:
• Time horizon

• Planning vs. control

• Level of detail

• Economic conditions in the market (stability vs. state of flux)

2.3. Technique Selection

Forecasters depend on:

• The characteristics of the forecasting method
 Forecast horizon

 Pattern of data

 Type of model

 Costs associated with the model

 Level of accuracy and ease of application

2.3. Technique Selection

Forecasting Techniques for Stationary Data

When are Stationary forecasting techniques used?

• The forces generating a series have stabilized, and the

environment in which the series exists is relatively unchanging.

Examples:
 the number of breakdowns per week on an assembly line having a
uniform production rate,

 the unit sales of a product or service in the maturation stage of its life
cycle,

 the number of sales resulting from a constant level of effort.

2.3. Technique Selection

Forecasting Techniques for Stationary Data

When are Stationary forecasting techniques used?

 A very simple model is needed because of a lack of data or for

ease of explanation or implementation.

 Stability may be obtained by making simple corrections for

factors such as population growth or inflation.

Examples:
 changing income to per capita income

 changing dollar sales to constant dollar amounts.

2.3. Technique Selection

Forecasting Techniques for Stationary Data

When are Stationary forecasting techniques used?

• The series may be transformed into a stable one.

Examples:

transforming a series by taking logarithms, square roots, or

differences.

• The series is a set of forecast errors from a forecasting

technique that is considered adequate.
2.3. Technique Selection

Forecasting Techniques for Stationary Data

• naive methods,

• simple averaging methods,

• moving averages,

• autoregressive moving average (ARMA) models

2.3. Technique Selection

Forecasting Techniques for Data with a Trend

When are forecasting techniques for trending data used?

• Increased productivity and new technology lead to changes in

lifestyle.

Examples
 the demands for electronic components, which increased with the
advent of the computer

 railroad usage which decreased with the advent of the airplane.

2.3. Technique Selection

Forecasting Techniques for Data with a Trend

When are forecasting techniques for trending data used?

• Increasing population causes increases in demand for goods

and services.

Examples
 the sales revenues of consumer goods,

 demand for energy consumption,

 use of raw materials.

2.3. Technique Selection

Forecasting Techniques for Data with a Trend

When are forecasting techniques for trending data used?

• The purchasing power of the dollar affects economic variables

due to inflation.

Examples:
 salaries,

 production costs,

 prices
2.3. Technique Selection

Forecasting Techniques for Data with a Trend

When are forecasting techniques for trending data used?

• The purchasing power of the dollar affects economic variables

due to inflation.

Examples:
 salaries,

 production costs,

 Prices

• Market acceptance increases.

Example: the growth period in the life cycle of a new product.

2.3. Technique Selection

Forecasting Techniques for Data with a Trend

 Moving Averages,

 Holt’s Linear Exponential Smoothing,

 Simple Regression,

 Growth Curves,

 Exponential Models,

 Autoregressive Integrated Moving Average (ARIMA) Models (Box-jenkins

Methods).
2.3. Technique Selection

Forecasting Techniques for Seasonal Data

• Weather influences the variable of interest.
Examples
 electrical consumption,
 summer and winter activities (e.g., sports such as skiing),
 clothing, and agricultural growing seasons.
• The annual calendar influences the variable of interest.
Examples:
 retail sales influenced by holidays,
 retail sales influenced by three-day weekends,
 retail sales influenced by school calendars.
2.3. Technique Selection

Forecasting Techniques for Seasonal Data

 Classical Decomposition,
 Winter’s Exponential Smoothing,
 Multiple Regression,
 ARIMA Models (Box-jenkins Methods).
2.3. Technique Selection

Forecasting Techniques for Cyclical Series

Forecasting techniques for cyclical data are used in:
• The business cycle influences the variable of interest.
Examples are economic, market, and competition factors.
• Shifts in popular tastes occur.
Examples are fashions, music, and food.
• Shifts in population occur.
Examples are wars, famines, epidemics, and natural disasters.
• Shifts in product life cycle occur.
Examples are introduction, growth, maturation and market saturation, and
decline.
2.3. Technique Selection

Forecasting Techniques for Cyclical Series

 Classical Decomposition,
 Economic Indicators,
 Econometric Models,
 Multiple Regression,
 ARIMA Models (Box-jenkins Methods).
2.3. Technique Selection
2.4. Model Evaluation

Forecasters depend on:

• The level of error associated with each model.

• Error is computed and looked at graphically.

• Control charts are used for model evaluations.

• Turning point diagram is used to evaluate a model.

2.4. Model Evaluation

• A pattern of cumulative errors moving systematically

away from zero in either direction is a signal that the
model is generating biased forecasts.

• Management has to establish the upper and lower control

limits.

• One fairly common rule of thumb is that the control limits

are equal to 2 or 3 time the standard error.
2.4. Model Evaluation

30
25
20
15
Cumulative Error

10 Model A
5 Model B
0 Model C
-5 Model D
-10
-15
-20
-25
Time
2.4. Model Evaluation

Actual Change
Y

Line of Perfect Forecast

II–Turning Point Error IB–Underestimate
Prediction of downturn of Positive
that did not occur; or change
failure to predict an IA–Overestimate
upturn of Positive change

IIIA–Overestimate of Ŷ Forecast

Negative change Change
IV–Turning Point Error
Prediction or upturn
that did not occur; or failure
to predict a downturn
IIIB–Underestimate
of Negative change

Figure 2.6 Turning Point Error Diagram

2.4. Model Evaluation

Actual Change
400

300

200
Forecast Change

100

0
-300 -200 -100 0 100 200 300 400
-100

-200

-300

-400
Chapter Summary

• Data Patterns

• Forecasting Methodologies

• Technique Selection

• Model Evaluation