FORECASTING - a method for translating past experience into estimates of the future.

Forecasting is the process of making statements about events whose actual outcomes (typically) have not yet been observed. A commonplace example might be estimation of the expected value for some variable of interest at some specified future date. Prediction is a similar, but more general term. Both might refer to formal statistical methods employing time series, cross-sectional or longitudinal data, or alternatively to less formal judgemental methods. Usage can differ between areas of application: for example in hydrology, the terms "forecast" and "forecasting" are sometimes reserved for estimates of values at certain specific future times, while the term "prediction" is used for more general estimates, such as the number of times floods will occur over a long period. Risk and uncertainty are central to forecasting and prediction; it is generally considered good practice to indicate the degree of uncertainty attaching to forecasts. The process of climate change and increasing energy prices has led to the usage of Egain Forecasting of buildings. The method uses Forecasting to reduce the energy needed to heat the building, thus reducing the emission of greenhouse gases. Forecasting is used in the practice of Customer Demand Planning in every day business forecasting for manufacturing companies. The discipline of demand planning, also sometimes referred to as supply chain forecasting, embraces both statistical forecasting and a consensus process. An important, albeit often ignored aspect of forecasting, is the relationship it holds with planning. Forecasting can be described as predicting what the future will look like, whereas planning predicts what the future should look like.[1] There is no single right forecasting method to use. Selection of a method should be based on your objectives and your conditions (data etc.).[2] A good place to find a method, is by visiting a selection tree. An example of a selection tress can be found here.[3]. Forecasting is the estimation of the value of a variable (or set of variables) at some future point in time. In this note we will consider some methods for forecasting. A forecasting exercise is usually carried out in order to provide an aid to decision-making and in planning the future. Typically all such exercises work on the premise that if we can predict what the future will be like we can modify our behaviour now to be in a better position, than we otherwise would have been, when the future arrives. Applications for forecasting include:

inventory control/production planning - forecasting the demand for a product enables us to control the stock of raw materials and finished goods, plan the production schedule, etc investment policy - forecasting financial information such as interest rates, exchange rates, share prices, the price of gold, etc. This is an area in which no one has yet developed a reliable (consistently accurate) forecasting technique (or at least if they have they haven't told anybody!) economic policy - forecasting economic information such as the growth in the economy, unemployment, the inflation rate, etc is vital both to government and business in planning for the future.

Forecasting involves the generation of a number, set of numbers, or scenario that corresponds to a future occurrence. It is absolutely essential to short-range and longrange planning. By definition, a forecast is based on past data, as opposed to a prediction, which is more subjective and based on instinct, gut feel, or guess. For example, the evening news gives the weather "forecast" not the weather "prediction." Regardless, the terms forecast and prediction are often used inter-changeably. For example, definitions of regressiona technique sometimes used in forecastinggenerally state that its purpose is to explain or "predict." Forecasting is based on a number of assumptions: 1. The past will repeat itself. In other words, what has happened in the past will happen again in the future. 2. As the forecast horizon shortens, forecast accuracy increases. For instance, a forecast for tomorrow will be more accurate than a forecast for next month; a forecast for next month will be more accurate than a forecast for next year; and a forecast for next year will be more accurate than a forecast for ten years in the future. 3. Forecasting in the aggregate is more accurate than forecasting individual items. This means that a company will be able to forecast total demand over its entire spectrum of products more accurately than it will be able to forecast individual stock-keeping units (SKUs). For example, General Motors can more accurately forecast the total number of cars needed for next year than the total number of white Chevrolet Impalas with a certain option package. 4. Forecasts are seldom accurate. Furthermore, forecasts are almost never totally accurate. While some are very close, few are "right on the money." Therefore, it is wise to offer a forecast "range." If one were to forecast a demand of 100,000 units for the next month, it is extremely unlikely that demand would equal 100,000 exactly. However, a forecast of 90,000 to 110,000 would provide a much larger target for planning. William J. Stevenson lists a number of characteristics that are common to a good forecast: Accuratesome degree of accuracy should be determined and stated so that comparison can be made to alternative forecasts.

Reliablethe forecast method should consistently provide a good forecast if the user is to establish some degree of confidence. Timelya certain amount of time is needed to respond to the forecast so the forecasting horizon must allow for the time necessary to make changes. Easy to use and understandusers of the forecast must be confident and comfortable working with it. Cost-effectivethe cost of making the forecast should not outweigh the benefits obtained from the forecast.

Forecasting techniques range from the simple to the extremely complex. These techniques are usually classified as being qualitative or quantitative. Forecasting is the establishment of future expectations by the analysis of past data, or the formation of opinions. Forecasting methods can be classified into several different categories:

qualitative methods - where there is no formal mathematical model, often because the data available is not thought to be representative of the future (long-term forecasting) regression methods - an extension of linear regression where a variable is thought to be linearly related to a number of other independent variables multiple equation methods - where there are a number of dependent variables that interact with each other through a series of equations (as in economic models) time series methods - where we have a single variable that changes with time and whose future values are related in some way to its past values.

TIME SERIES FORECASTING METHODS time series forecasting methods are based on analysis of historical data (time series: a set of observations measured at successive times or over successive periods). They make the assumption that past patterns in data can be used to forecast future data points. 1. moving averages (simple moving average, weighted moving average): forecast is based on arithmetic average of a given number of past data points 2. exponential smoothing (single exponential smoothing, double exponential smoothing): a type of weighted moving average that allows inclusion of trends, etc. 3. mathematical models (trend lines, log-linear models, Fourier series, etc.): linear or non-linear models fitted to time-series data, usually by regression methods 4. Box-Jenkins methods: autocorrelation methods used to identify underlying time series and to fit the "best" model COMPONENTS OF TIME SERIES DEMAND 1. average: the mean of the observations over time 2. trend: a gradual increase or decrease in the average over time 3. seasonal influence: predictable short-term cycling behaviour due to time of day, week, month, season, year, etc.

4. cyclical movement: unpredictable long-term cycling behaviour due to business cycle or product/service life cycle 5. random error: remaining variation that cannot be explained by the other four components In statistics, signal processing and mathematical finance, a time series is a sequence of data points, measured typically at successive times spaced at uniform time intervals. Examples of time series are the daily closing value of the Dow Jones index or the annual flow volume of the Nile River at Aswan. Time series analysis comprises methods for analyzing time series data in order to extract meaningful statistics and other characteristics of the data. Time series forecasting is the use of a model to forecast future events based on known past events: to predict data points before they are measured. An example of time series forecasting in econometrics is predicting the opening price of a stock based on its past performance. Time series data have a natural temporal ordering. This makes time series analysis distinct from other common data analysis problems, in which there is no natural ordering of the observations (e.g. explaining people's wages by reference to their education level, where the individuals' data could be entered in any order). Time series analysis is also distinct from spatial data analysis where the observations typically relate to geographical locations (e.g. accounting for house prices by the location as well as the intrinsic characteristics of the houses). A time series model will generally reflect the fact that observations close together in time will be more closely related than observations further apart. In addition, time series models will often make use of the natural one-way ordering of time so that values for a given period will be expressed as deriving in some way from past values, rather than from future values (see time reversibility.) Methods for time series analyses may be divided into two classes: frequency-domain methods and time-domain methods. The former include spectral analysis and recently wavelet analysis; the latter include auto-correlation and cross-correlation analysis. In statistics, regression analysis includes any techniques for modeling and analyzing several variables, when the focus is on the relationship between a dependent variable and one or more independent variables. More specifically, regression analysis helps us understand how the typical value of the dependent variable changes when any one of the independent variables is varied, while the other independent variables are held fixed. Most commonly, regression analysis estimates the conditional expectation of the dependent variable given the independent variables that is, the average value of the dependent variable when the independent variables are held fixed. Less commonly, the focus is on a quantile, or other location parameter of the conditional distribution of the dependent variable given the independent variables. In all cases, the estimation target is a function of the independent variables called the regression function. In regression analysis, it is also of interest to characterize the variation of the dependent variable around the regression function, which can be described by a probability distribution.

Regression analysis is widely used for prediction and forecasting, where its use has substantial overlap with the field of machine learning. Regression analysis is also used to understand which among the independent variables are related to the dependent variable, and to explore the forms of these relationships. In restricted circumstances, regression analysis can be used to infer causal relationships between the independent and dependent variables. A large body of techniques for carrying out regression analysis has been developed. Familiar methods such as linear regression and ordinary least squares regression are parametric, in that the regression function is defined in terms of a finite number of unknown parameters that are estimated from the data. Nonparametric regression refers to techniques that allow the regression function to lie in a specified set of functions, which may be infinite-dimensional. The performance of regression analysis methods in practice depends on the form of the data-generating process, and how it relates to the regression approach being used. Since the true form of the data-generating process is not known, regression analysis depends to some extent on making assumptions about this process. These assumptions are sometimes (but not always) testable if a large amount of data is available. Regression models for prediction are often useful even when the assumptions are moderately violated, although they may not perform optimally. However, in many applications, especially with small effects or questions of causality based on observational data, regression methods give misleading results.[1][2] Regression models involve the following variables:

The unknown parameters denoted as ; this may be a scalar or a vector of length k. The independent variables, X. The dependent variable, Y.

A regression model relates Y to a function of X and .

SIMPLE MOVING AVERAGE moving average techniques forecast demand by calculating an average of actual demands from a specified number of prior periods each new forecast drops the demand in the oldest period and replaces it with the demand in the most recent period; thus, the data in the calculation "moves" over time simple moving average: At = Dt + Dt-1 + Dt-2 + ... + Dt-N+1

N where N = total number of periods in the average forecast for period t+1: Ft+1 = At WEIGHTED MOVING AVERAGE a weighted moving average is a moving average where each historical demand may be weighted differently average: At = W1 Dt + W2 Dt-1 + W3 Dt-2 + ... + WN Dt-N+1 where: N = total number of periods in the average Wt = weight applied to period t's demand
Sum of all the weights = 1

forecast: Ft+1 = At = forecast for period t+1 EXPONENTIAL SMOOTHING exponential smoothing gives greater weight to demand in more recent periods, and less weight to demand in earlier periods average: At = a Dt + (1 - a) At-1 = a Dt + (1 - a) Ft forecast for period t+1: Ft+1 = At where: At-1 = "series average" calculated by the exponential smoothing model to period t-1 a = smoothing parameter between 0 and 1 the larger the smoothing parameter , the greater the weight given to the most recent demand . A more complex form of weighted moving average is exponential smoothing, so named because the weight falls off exponentially as the data ages. Exponential smoothing takes the previous period's forecast and adjusts it by a predetermined smoothing constant, (called alpha; the value for alpha is less than one) multiplied by the difference in the previous forecast and the demand that actually occurred during the previously forecasted

period (called forecast error). Exponential smoothing is expressed formulaically as such: New forecast = previous forecast + alpha (actual demand previous forecast) F = F + (A F) Exponential smoothing requires the forecaster to begin the forecast in a past period and work forward to the period for which a current forecast is needed. A substantial amount of past data and a beginning or initial forecast are also necessary. The initial forecast can be an actual forecast from a previous period, the actual demand from a previous period, or it can be estimated by averaging all or part of the past data.

(TREND-ADJUSTED EXPONENTIAL SMOOTHING) when a trend exists, the forecasting technique must consider the trend as well as the series average ignoring the trend will cause the forecast to always be below (with an increasing trend) or above (with a decreasing trend) actual demand double exponential smoothing smooths (averages) both the series average and the trend forecast for period t+1: Ft+1 = At + Tt average: At = aDt + (1 - a) (At-1 + Tt-1) = aDt + (1 - a) Ft average trend: Tt = B CTt + (1 - B) Tt-1 current trend: CTt = At - At-1 forecast for p periods into the future: Ft+p = At + p Tt where: At = exponentially smoothed average of the series in period t Tt = exponentially smoothed average of the trend in period t CTt = current estimate of the trend in period t a = smoothing parameter between 0 and 1 for smoothing the averages B = smoothing parameter between 0 and 1 for smoothing the trend MULTIPLICATIVE SEASONAL METHOD What happens when the patterns you are trying to predict display seasonal effects?

What is seasonality? - It can range from true variation between seasons, to variation between months, weeks, days in the week and even variation during a single day or hour. To deal with seasonal effects in forecasting two tasks must be completed: 1. a forecast for the entire period (ie year) must be made using whatever forecasting technique is appropriate. This forecast will be developed using whatever 2. the forecast must be adjust to reflect the seasonal effects in each period (ie month or quarter) the multiplicative seasonal method adjusts a given forecast by multiplying the forecast by a seasonal factor CAUSAL FORECASTING METHODS causal forecasting methods are based on a known or perceived relationship between the factor to be forecast and other external or internal factors 1. regression: mathematical equation relates a dependent variable to one or more independent variables that are believed to influence the dependent variable 2. econometric models: system of interdependent regression equations that describe some sector of economic activity 3. input-output models: describes the flows from one sector of the economy to another, and so predicts the inputs required to produce outputs in another sector 4. simulation modelling MEASURING FORECAST ERRORS There are two aspects of forecasting errors to be concerned about - Bias and Accuracy Bias - A forecast is biased if it errs more in one direction than in the other - The method tends to under-forecasts or over-forecasts. Accuracy - Forecast accuracy refers to the distance of the forecasts from actual demand ignore the direction of that error.

QUALITATIVE TECHNIQUES
Qualitative forecasting techniques are generally more subjective than their quantitative counterparts. Qualitative techniques are more useful in the earlier stages of the product life cycle, when less past data exists for use in quantitative methods. Qualitative methods

include the Delphi technique, Nominal Group Technique (NGT), sales force opinions, executive opinions, and market research.

THE DELPHI TECHNIQUE.

The Delphi technique uses a panel of experts to produce a forecast. Each expert is asked to provide a forecast specific to the need at hand. After the initial forecasts are made, each expert reads what every other expert wrote and is, of course, influenced by their views. A subsequent forecast is then made by each expert. Each expert then reads again what every other expert wrote and is again influenced by the perceptions of the others. This process repeats itself until each expert nears agreement on the needed scenario or numbers.

NOMINAL GROUP TECHNIQUE.

Nominal Group Technique is similar to the Delphi technique in that it utilizes a group of participants, usually experts. After the participants respond to forecast-related questions, they rank their responses in order of perceived relative importance. Then the rankings are collected and aggregated. Eventually, the group should reach a consensus regarding the priorities of the ranked issues.

SALES FORCE OPINIONS.

The sales staff is often a good source of information regarding future demand. The sales manager may ask for input from each sales-person and aggregate their responses into a sales force composite forecast. Caution should be exercised when using this technique as the members of the sales force may not be able to distinguish between what customers say and what they actually do. Also, if the forecasts will be used to establish sales quotas, the sales force may be tempted to provide lower estimates.

EXECUTIVE OPINIONS.
Sometimes upper-levels managers meet and develop forecasts based on their knowledge of their areas of responsibility. This is sometimes referred to as a jury of executive opinion.

MARKET RESEARCH.
In market research, consumer surveys are used to establish potential demand. Such marketing research usually involves constructing a questionnaire that solicits personal, demographic, economic, and marketing information. On occasion, market researchers collect such information in person at retail outlets and malls, where the consumer can experiencetaste, feel, smell, and seea particular product. The researcher must be careful that the sample of people surveyed is representative of the desired consumer target.

QUANTITATIVE TECHNIQUES
Quantitative forecasting techniques are generally more objective than their qualitative counterparts. Quantitative forecasts can be time-series forecasts (i.e., a projection of the past into the future) or forecasts based on associative models (i.e., based on one or more explanatory variables). Time-series data may have underlying behaviors that need to be identified by the forecaster. In addition, the forecast may need to identify the causes of the behavior. Some of these behaviors may be patterns or simply random variations. Among the patterns are:

Trends, which are long-term movements (up or down) in the data. Seasonality, which produces short-term variations that are usually related to the time of year, month, or even a particular day, as witnessed by retail sales at Christmas or the spikes in banking activity on the first of the month and on Fridays. Cycles, which are wavelike variations lasting more than a year that are usually tied to economic or political conditions. Irregular variations that do not reflect typical behavior, such as a period of extreme weather or a union strike. Random variations, which encompass all non-typical behaviors not accounted for by the other classifications.

ECONOMETRIC FORECASTING
Econometric methods, such as autoregressive integrated moving-average model (ARIMA), use complex mathematical equations to show past relationships between demand and variables that influence the demand. An equation is derived and then tested and fine-tuned to ensure that it is as reliable a representation of the past relationship as possible. Once this is done, projected values of the influencing variables (income, prices, etc.) are inserted into the equation to make a forecast. Business impact analysis (BIA) is an essential component of an organization's business continuance plan; it includes an exploratory component to reveal any vulnerabilities, and a planning component to develop strategies for minimizing risk. The result of analysis is a business impact analysis report, which describes the potential risks specific to the organization studied. Assessment of the pros and cons of pursuing a course of action in light of its possible consequences, or the extent and nature of change it may cause.