Time Series Forecasting

Van Hoang 2045 S. Volutsia Wichita, KS 67211 (316) 612 0882

Wichita State University

Van Hoang (B.S. Chemistry-Business Wichita State University) is currently a full-time graduate student in Industrial Engineering at Wichita State University, Wichita Kansas

APICS Wichita Student Chapter S232

Abstract Time series forecasting is a simple and direct quantitative forecasting method used in operation management. Moving average, exponential smoothing without a trend, and exponential smoothing with a linear trend are some of the models used to predict future demand. This paper will describe these models and its usage in operation management and the common quantitative measures to evaluate these forecasting models. Introduction Time series forecasting is one of the most common forecasting techniques used in operation management due to its simplicity and ease of usage. Here, time series prefers to a sequence of observations of past data (6). The forecast values could be a point forecast or a confidence interval forecast (2). For example, when an aircraft company is using time series forecasting method to predict future demand of jets it will sell within the next week period, the forecast could be eight jets, the value here is given as a point forecast. The confidence interval forecast could be 95% meaning that the forecaster assumes the forecast is accurate with 95% confidence interval. In this paper, only point forecast would be used due to its simplicity. Before choosing which forecasting method should be used, the company has to consider a variety of factors that would affect the forecast such as availability of data, data pattern, time frame, accuracy desired, and cost of forecasting (2). Time series forecasting is generally applied in short term forecast horizon and commonly used for inventory control (5). Time series forecasting also associates with low cost which make it more preferable compared to other methods.

For ease of understanding, many data examples are present in this paper and all of them are made-up by the writer with no actual basis. Time Series Forecasting Models Based on the data pattern, different approaches and forecasting models would be used to predict the future demand of the desired product. Three models of time series forecasting being discussed here are moving average, exponential smoothing without a trend, and exponential smoothing with a linear trend. Moving Average Moving average is the simplest forecasting method used when the observed data shows no trend; an example is shown in Figure 1. The observed historical demand, A(t), shows no particular trend, thus the moving average method would be the preferred method to predict future demand, f(t + 1), the demand of the next period. The forecast is determined by calculating the average of the observed data. Nevertheless, calculating the average demand over the entire observed time frame would make the forecast less responsive to changes in future demand (4), therefore, only the most recent data are used to calculate the moving average. How big or how small the parameter n should be is entirely depended upon the forecasters assumption. In this example, a parameter of three months and five months are used. Two different parameters are used to show their different effects and the calculations can be observed in Table 1. Comparing the future forecast, f(t), presents in Figure 2. computed using n = 3 and n = 5, one can see that the greater the parameter n, the more stable the forecast is

while smaller n is more prone to changes. Since the historical observed data shows no particular trend, the forecast does not show any trend either. Moving average forecast f(t + 1) = F(t) F(t) = A(t) n

10 8

Demand

6 Demand A(t) 4 2 0 1 2 3 4 5 6 7 8 9 10 Month

FIGURE 1. Observed Historical Data Month (t) 1 2 3 4 5 6 7 8 9 10 Demand A(t) 6 7 5 7 8 9 3 4 5 5 (6 + 7 + 5) 3 = 6 (7 + 5 + 7) 3 = 6.33 (5 + 7 + 8) 3 = 6.67 (7 +8 + 9) 3 = 8 (8 + 9 + 3) 3 = 6.67 (9 + 3 + 4) 3 = 5.33 (3 + 4 + 5) 3 = 4 (6 + 7 + 5 + 7 + 8) 5 = 6.6 (7 + 5 + 7 + 8 + 9) 5 = 7.2 (5 + 7 + 8 + 9 + 3) 5 = 6.4 (7 + 8 + 9 + 3 + 4) 5 = 6.2 (8 + 9 + 3 + 4 + 5) 5 = 5.8 Forecast f(t) with n = 3 Forecast f(t) with n = 5

TABLE 1. Moving Average with n = 3 and n = 5

10 9 8 7

Demand

6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 Month

Demand A(t) f(t) with n = 3 f(t) with n = 5

FIGURE 2. Moving Average with n = 3 and n = 5 Exponential Smoothing without a Trend Exponential smoothing without a trend is another forecasting method that could be applied to observed data that shows no trend like the one in Figure 1. The key difference between exponential smoothing without a trend and moving average is that exponential smoothing has a self-adjusting mechanism that would adjust previous forecast error. On top of that, older data is out-weighted by more recent data in this method, assuming that the more recent data has a greater link to the future forecast comparing to the older ones (5). In the equation below, F(t) represents the smooth series of period t, is the smoothing constant between zero and one, F(t-1) is the previous forecast, and A(t) is the actual demand observed in period t. Choosing the smoothing constant is solely depended on the forecasters assumption, just like how he or she picks what value of n to use in the moving average

method. An example of exponential smoothing without a trend is shown in Table 2 with smoothing constant of 0.3 and 0.5. The data present in Table 1 and Table 2 are the same, but different forecasting approaches were used thus generating different forecast. As can be seen in Figure 3., a smaller smoothing constant is more stable and less responsive to changes and vice versa when a greater smoothing constant is used. Nevertheless, the forecasts present do not match up with the historical data very well; they fail to predict the increase or decrease in demand, just remain neutral in the middle of the up and down of the historical data. Exponential Smoothing without a Trend Month (t) 1 2 3 4 5 6 7 8 9 10 Demand A(t) 6 7 5 7 8 9 3 4 5 5 F(t )= A(t) + (1-)F(t-1) f(t + 1) = F(t)

Forecast F(t) with = 0.3 F(1) = A(1) = 6 (0.3)(7) + (1 0.3)(6) = 6.3 (0.3)(5) + (1 0.3)(6.3) = 5.91 (0.3)(7) + (1 0.3)(5.91) = 6.24 (0.3)(8) + (1 0.3)(6.24) = 6.77 (0.3)(9) + (1 0.3)(6.77) = 7.44 (0.3)(3) + (1 0.3)(7.44) = 6.11 (0.3)(4) + (1 0.3)(6.11) = 5.48 (0.3)(5) + (1 0.3)(5.48) = 5.34

Forecast F(t) with = 0.5 F(1) = A(1) = 6 (0.5)(7) + (1 0.5)(6) = 6.5 (0.5)(5) + (1 0.5)(6.5) = 5.75 (0.5)(7) + (10.5)(5.75) = 6.38 (0.5)(8) +(10.5)(6.38) = 7.19 (0.5)(9) + (10.5)(7.19) = 8.10 (0.5)(3) + (10.5)(8.10) = 5.55 (0.5)(4) + (10.5)(5.55) = 4.78 (0.5)(5) + (10.5)(4.78) = 4.89

TABLE 2. Exponential Smoothing without a Trend using = 0.3 and = 0.5

10 9 8

Demand

7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 Month

Demand A(t) = 0.3 = 0.5

FIGURE 3. Exponential Smoothing without a Trend Exponential Smoothing with a Linear Trend When observed historical demand shows a linear trend, then exponential smoothing with a linear trend would be the appropriate method to use. In this method, the same equation for exponential smoothing without a trend is used, in addition to that, the trend, T(t), is also needed. To calculate the trend, another smoothing constant, , ranging from zero to one is needed, and which value to be used is solely depended upon the forecaster. For the most part, a trail of various and are used to calculate the forecast, and the ones that predict the forecast that follow the trend of the historical demand best are chosen. Looking at the example data present in Figure 4., here the historical demand shows an increasing trend, thus, exponential smoothing with a linear trend method is applied to calculate for the forecast. Smoothing constant at 0.2 is used for both and

, though these values do not have to be the same. The forecast also shows an increasing trend along with the observed demand. Exponential Smoothing with a Linear Trend Trend F(t) = A(t) + (1-)[F(t-1) + T(t-1)] T(t) = [F(t) F(t-1)] + (1 )T(t-1) f(t + 1) = F(t) + T(t) Demand A(t) 10 12 12 11 15 14 18 22 18 28 Smoothed Estimate F(t) 10 10.4 10.78 10.94 11.87 12.53 13.93 16 17.1 20.02 Smoothed Trend T(t) 0 0.08 0.14 0.14 0.3 0.37 0.58 0.88 0.92 1.32 10 10.48 10.92 11.08 12.17 12.91 14.5 16.88 18.03 Forecast f(t)

TABLE 3. Exponential Smoothing with a Linear Trend when = 0.2 and = 0.2

30 25

Demand

20 15 10 5 0 1 2 3 4 5 6 7 8 9 10 Month Demand A(t) Forecast f(t)

FIGURE 4. Exponential Smoothing with a Linear Trend Evaluating Forecasting Models In order to determine which method is the most appropriate to apply, certain measurements should be performed to give a fair comparison on time series with different standard deviation (1). Two simple quantitative measures are mean absolute deviation (MAD) and mean square deviation (MSD)(3). The MAD measure takes the absolute differences between the forecast and the actual demand divided by the number of period to generate a numerical score while the MSD measure takes the square of the differences between the forecast and the actual demand and then divide that value by the number of periods. Through both methods, only positive values would be obtained, thus, the goal is to look for the smoothing constant that would generate the lowest MAD or MSD (4). In order to so, a trial of different value of and are tested to generate the lowest MAD or MSD possible. Nevertheless, the and combination that leads to the smallest MAD value may not lead to the smallest MSD value, and thus the forecaster has to decide which measurement to use.

Conclusions The time series forecasting methods listed above are some of the basic forecasting techniques that are simple to apply. Since there is no single best forecasting method, a combination of forecasting methods could be used as long that it nicely fit with the situation. Though detail observations and calculations are carried out to make a forecast, a forecast is still just a forecast; it is nothing more than a prediction of the non-absolute future. There is always uncertainty, thus, forecast should only be used as guide and should not be fully depended upon.

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