AI and how it’s transforming the financial markets

By Samuel leach, Director of Samuel and Co Trading

In the modern era, it has become apparent that the use of AI has transformed the financial markets. The influence of custom-made algorithms specifically designed to conquer various asset classes in the hopes of outperforming the market has grown to the forefront of large funds and investment firms. It has become so integral to the success of many of these multi-trillion-dollar asset management companies and hedge funds, that they focus the majority of their attention and resources towards developing new algorithms.

This transition can be seen in the recruitment of large banks, who in the last 30 years have gone from recruiting traders to place manual trades on a stock exchange trade floor to now hiring computer science wizards and tech teams. Now, many financial services companies prioritise recruiting individuals based on their knowledge of computer systems and networks than their financial background. This has created a technological revolution, where these robots and algorithms have so much power across all financial markets that they decide exactly what happens next. So how did we get here and why could this be a problem?

As computers have become so ingrained in our daily lives, the competence of these systems have become so advanced that they outperform humans in almost every different domain. With financial markets being heavily quantitative, AI has grown in popularity for a number of reasons. The sheer amount of processing power in a fraction of a second and the absence of human emotion allows these robots to make high-quality, informed decisions faster than whole teams of experts in the field. Therefore, large funds are prepared to invest heavily into whichever algorithm will give them the best return.

For example, ALADDIN (which stands for asset, liability, debt, and derivative investment network), an AI-based portfolio system owned by BlackRock, the world’s largest asset management company, manages over $21 trillion. To put this in perspective, the total US stock market valuation is around $100 trillion, making just this one algorithm hold over 20% of the total US stock market. This is due to its software being licensed to the other biggest asset management companies, such as Vanguard and State Street Global Advisors. This is particularly concerning due to the fact that firms like Vanguard manage a wide number of the population’s pension and retirement plans, putting AI systems like ALADDIN in a position to influence the future of millions of people.

If algorithms manage the majority of the capital in the financial markets, it could be argued that they have the ability to manipulate the markets in whatever way they like. Holding the power to decide where capital flows, gives AI the capacity to pick who wins and who loses. This can be an issue as it may overpower the merit of a company itself. Rather than the market as a whole backing strong performing companies for future long-term growth, AI robots can boost individual stock prices for short-term profit. This is also true for those who lose; If 20% of the market was sold in a short space of time, would it not lead to a significant market crash?

Now, there are counterarguments, in support of AI systems and management networks. Firstly, it can provide more sustainability as assets are distributed in a balanced way across a variety of financial markets. Continued support through large funds allows for market liquidity to remain consistent, permitting sustainable market performance. Many of these funds have close ties to regulators, central bank members, and politicians. Although this can have negative connotations, a positive argument can be made for sustainability and protection. Investors can feel a sense of security, knowing that they have large funds backing their investments and maintaining stabilisation of their retirement account(s).

Also, algorithms are not only used by some of the largest funds in the world. They can also be extremely useful for individual investors to achieve a sustainable return on their portfolio. For example, Samuel & Co Trading are well known in the trading industry for the expert advisors they offer for individual investors of any background. Samuel & Co Trading have gained a strong reputation and large following due to the variety of algorithms available, across a variety of different financial instruments, with a proven track record of high-performing returns. They have recently released a Volatility Index (VIX) algorithm, which aims to capture volatility moves in the markets, allowing individuals the ability to diversify their portfolio from other traditional asset classes. As you can see, the influence of AI and algorithms within the markets can also be beneficial for investors across the world.

Overall, whether the influence of AI in the world of trading and financial markets as a whole, is a positive or negative one; the influence is unlikely to change. Only time will tell what the long-term consequences will be. What we do know at this time is that algorithms have completely transformed every aspect of the financial markets and this will likely continue to transpire. We can reasonably expect that as computational power increases, so will the dominance of AI for asset management and stock market performance. Many of these AI systems are used by both large funds and individual investors alike. This means that the market is constantly searching for new innovative algorithms to not just diversify their portfolio, but also outperform the rest of the market.