The intuition behind the Fourier Transform

The Fourier Transform is a tool that transforms complex stock price movements into simpler, frequency-based components. In a mathematical context, this transformation is executed through a specified formula that facilitates a detailed analysis of the stock price movements at various frequency levels.

The mathematical foundation of this process lies in the formula F(w) = ∫_(-∞)^(∞) f(x) * e^(-jwx) dx. Here, f(x) represents the time-domain data of a stock’s price, and F(w) gives its frequency-domain counterpart.

In the context of a specific stock, f(x) would represent the stock's price movements over a designated period. The Fourier Transform equation helps decompose these movements into different frequencies, each associated with a distinct aspect of the stock’s behaviour.

Mathematically, high-frequency components are identified as those where the value of w (angular frequency *) is large. These components capture rapid fluctuations in the stock price, which could be mathematically represented as oscillations occurring over short intervals of the time-domain data, f(x).

Mid-Frequency components are captured when w is at intermediate values. Mathematically, these components identify patterns and cycles that occur at regular, but not rapid, intervals within the time-series data. They signify periodic events or trends impacting the stock’s price.

Low-Frequency components represented mathematically where the value of w is small, these components reflect long-term, slow-changing trends in the stock’s price. They capture the underlying movements in the data f(x) that unfold over extended periods.

When applying the Fourier Transform to the time-series data of Apple Inc.'s stock prices for example, each frequency component reveals specific trends. 

The high-frequency components might unveil the stock’s sensitivity to daily news or market sentiment, mid-frequency components could reveal price patterns associated with recurring events like product launches or quarterly earnings and low-frequency components might highlight long-term trends shaped by macroeconomic factors or the company’s overall growth.

By examining these isolated frequency components mathematically, analysts can quantitatively assess the impact of various influences on the stock's price.

(*)

Frequency refers to the number of occurrences of a repeating event per unit of time. In the context of waveforms and signals, it describes how often a wave’s cycle repeats in a second. The standard unit of frequency is the hertz (Hz), equivalent to one occurrence or cycle per second.

Angular frequency, often denoted by (omega ), is a measure of how fast something oscillates or cycles in radians per unit of time. It’s related to the frequency of oscillation and is particularly used in the context of waveforms and harmonic oscillations.

#FourierTransform #StockAnalysis #FinancialMathematics#FrequencyAnalysis #QuantitativeFinance #StockPriceMovements


The Fourier Transform in layman’s terms…
The Fourier Transform in layman’s terms…

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