By: Neil Szczepanski, Tradeology
In order to best understand the effect of Artificial Intelligence (AI) on retail trading one must first understand what AI is.
AI is the simulation of human intelligence processes by machines, especially computer systems. Particular applications of AI including expert systems, speech recognition and machine vision.
When we think of AI we tend to think in the extreme sense like it was portrayed in the famous movie from the early 1980s, Terminator. Machines became so smart so fast they threatened humankind and took over the world.
In reality, it would be very difficult for this to happen. Why? Because AI currently is not good at working with imperfect datasets. Rather they need all the data at their fingertips to be able to quickly analyze through a feedback learning loop to refine the information over hundreds of thousands of times in a perfect dataset. To survive in a human world a machine would have to be able to make decisions on data that doesn’t exist or an imperfect dataset. We humans control the feedback mechanism and the unknown data. Without these an AI could make bad decisions and expose their weaknesses.
So how does this effect retail trading. We have all heard of algorithmic trading which is a trading method of executing orders using automated pre-programmed trading instructions. It accounts for variables such as time, price and volume to send small slices of the order out to the market over time.
This is NOT AI. This is an old form AI now called an expert system. It is a series of if/then, that and this statements accounting for as many different variables as the developer can account for in a decision tree. There is no learning going on here nor is there any feedback loop. The only way an algorithm is improved is by the developer/trader making updates to their program logic in the decision tree. This type of trading has been going on for a long time and became more popular around 2006 as PC computing power became less expensive and speed could be achieved as an edge to trading. We have never really seen much of this in retail trading because it is expensive and hard to maintain. AI is a completely different thing than using an expert system. As the AI’s evolve and are able to dissect imperfect datasets I think we will see more automated trading systems that will not only execute trades but will be able to learn as they trade. Today AI is used by many hedge funds for discovering patterns, predicting trading based on sentiment and speed, but not to directly trade.
What does that mean for us humans? For a human retail trader to survive they will need to be able to understand how technology works in particular and how AI works so they can exploit its weaknesses for the retail trader’s gain. True AI has a feedback learning loop, but it doesn’t always make the right decisions (that’s what the feedback is for). If we can understand AI we can find the best trade setups and use technology against technology for our edge. Finding an edge will always be important in retail trading. The question becomes where do you find this edge in the future with AI?
Want to find out more about how tech can help you trade now and into the future? Visit Tradeology The Fifth Insight.
Disclaimer: The author is not a financial advisor and the following should not be taken as financial advice. This is by no means a complete discussion of the pros and cons of trading and/or investing. Please consult your own qualified advisors to determine what is appropriate and best suited to your specific investment objectives and risk tolerance.