Stock Trading Differences in the Age of Artificial Intelligence

The Bizarre Paradox of AI (Artificial Intelligence) based Stock Trading and the Efficient Market Hypothesis. Here are some things that stock traders need to be aware of in 2018.

May 9, 2018
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I can still remember reading about artificial intelligence when I was learning to write C++ code at the tender age of 15. If you asked me how artificial intelligence would change our lives, I would talk about the impact of video games or the future of robotics. The thought that AI could be used for stock trading never crossed my mind.

I have recently observed that AI has changed the world of financial trading in ways that I never envisioned. Here are some things that stock traders need to be aware of in 2018.

Artificial Intelligence is a Better Valuation of the Market than the Market Itself

During my MBA program, I heard professors talk extensively about the “efficient market hypothesis.” They said that the market was so efficient that it was impossible to beat it. A few experts like Warren Buffet have consistently realized higher returns than the market, which partially cast this theory into doubt. However, the vast majority of traders have been unable to realize higher than average returns, which made a stronger case for it.

AI is upending this conventional wisdom. Many algorithms have proven to be even more effective at valuing stocks than the market itself. Based on this data, a number of new equity firms have been launched with AI algorithms. Art Armador, co-founder of EquBot LLC, is one of the pioneers in this newly emerging field.

We were absolutely surprised by the degree of interest,” said Armador. “We launched with $2.5 million in assets and were hoping to get to $40 million by the end of the year. Instead, we got that within the first week and now north of $70 million. It blew our minds.

Artificial intelligence may not completely upend the efficient market hypothesis, but it is reframing the discussion. It is even changing the future of penny stocks.

AI-Based Stock Trading Could Become Useless Due to Its Own Effectiveness

It is a strange paradox when something collapses under the weight of its own success. This could very well be the case with AI stock trading.

Some experts have stated that AI trading platforms have made the market even more efficient, which is squeezing even their own edge.

“The rise of competing quant strategies has helped drive down available alpha by increasing the overall wisdom of crowds and shrinking the available alpha through more efficient markets,”

wrote Jordi Visser, chief investment officer at Weiss Multi-Strategy Advisers.

What does this mean for the future of AI? Will traders stop using it, due to it creating its own obsolescence? Or will relying on AI be essential to even have a chance at thriving in the market?

The most likely scenario is that companies with the most effective AI trading tools will be the ones that find an advantage in the market. Since AI is making the market so much more efficient, their competitive advantage will probably only give them the chance to make a very small return on any given trade. By my own personal estimates as both a big data pundit and former financial professional, I believe this could lead to yields as low as 0.1% a trade, after brokerage fees and VAT taxes are taken into account. However, this could be a massive return of over 330% over the course of a year if four such trades were placed every day. Of course, only the companies with the most resources could afford such sophisticated AI technology or the ability to withstand the steep brokerage fees that would erode the profits of much smaller firms.

What are the consequences of this? It will most likely lead to fewer people managing their own portfolios and more people investing with large institutions that can place the rights trades.