Artificial Intelligence: Real challenge for traders

Vikas SinghaniaTrade Smart OnlineFinancial markets globally are changing not only in terms of price movements, informed participants, increased money flow and volatility but also structurally. While the others have always been a part of changing markets, it is the structural change that has the tendency of being disruptive in nature. The first sign of change was visible in Chicago that was the last bastion of open outcry trading system. This summer Chicago Mercantile Exchange Group closed most of its trading pits after 167 years. The reason – machines. Algorithmic trading has fast replaced humans, accounting for nearly 70 per cent of trading volumes in leading exchanges globally. Where strategies are made for taking advantage of split second mispricing, human speed is of little use. In India algorithmic trading has just caught on, but globally the market has evolved to something called artificial intelligence. From SIRI (a computer program that works as a personal assistant) to self-driving cars, artificial intelligence is making its presence felt in various industries like healthcare, finance, agriculture and security. While in most other industries artificial intelligence has played a complimentary role, working with humans, in the world of finance it has a disruptive role, where it learns from humans and then replaces them. What makes artificial intelligence scary for the trading and investing world is its ability to improve as it gains more experience as it operates and consumes information. Large financial organisations like Goldman Sachs are using it to analyse big data and the impact of weather and real time events like news and events on financial markets. Other organisations are using it to perform high degree of technical analysis. Artificial Intelligence has demonstrated its superiority when competing with human in mind games like chess and ‘Jeopardy’. They are now at the door steps of financial world. If you think that it is still years before artificial intelligence come knocking at your door, consider this data. Nearly 40 per cent of all hedge funds launched last year were based on artificial intelligence. Since their official launch nearly seven years ago, funds based on artificial intelligence have outperformed the equity market and other funds. There are some that have been laggards, but the nature of the machine is such that it learns from its own mistakes and that of others to improve it. What gives artificial intelligence advantage is that they rely on intelligent quotient (IQ) and emotional quotient (EQ). Designed by some of the most intelligent mind in the world they are ‘taught’ to consume information at rapid speed, analyse and act. Humans can capture only so much data, but these machines can digest vast amount of data and are programmed in such a way that they reach a conclusion immediately and get on with the act. EQ is the more important aspect in trading. It distinguishes between success and failure. Being programmed, artificial intelligence completely skips through the EQ portion and repeats its tasks, learning and optimising from it. Humans would feel emotionally drained after a series of losses, machines have no such inhibitions. Market participants feel that artificial intelligence will replace analysts earlier than they will make fund managers’ redundant. An analyst’s job is largely collating data and making sense of it. Computers can be programmed to do both. Some of the most successful minds in the world like Elon Musk, Bill Gates and Stephen Hawking have warned about the threat of artificial intelligence to human race. Humans take years to perfect themselves, especially in trading it is a life time, still many remain unsuccessful, for machines the learning curve will be in minutes. Creators of this artificial intelligence software program the machines to adapt to changing market conditions, without guidance or instruction from humans. Currently the algorithmic way of trading needs to develop a mathematical model to identify opportunities. The model is then regularly updated to adapt to the changing environment. Artificial intelligence software’s just need human input in the beginning after which they are programmed to adapt learn and optimise. Thus if a trading strategy is not too profitable, it would either work to change it or jump to something that is making more money. Some software’s are designed to interpret how humans will react to a situation and take advantage of it. Or take the case of long term investing. All the program needs is to be inserted with the mathematical equivalent of Warren Buffett words to be fearful when others are greedy and greedy when everyone is fearful. The program calculates value in the stocks and picks up the best based on the analysis which it has been programmed to do before taking the final call. Some broking forms are using artificial intelligence at the retail level, where the software is fed basic information like income, risk profile and return expectation. The algorithm not only creates a portfolio for the person but manages and changes it on a daily basis to remain within the parameter. With artificial intelligence science fiction is soon becoming a reality, competing against these machines will be difficult. If one can’t defeat them, one can join them by selecting a fund that uses the best artificial intelligence software.