AI and how it is transforming financial markets

By Samuel leaching, Director of Samuel and Co Trading

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

This transition can be seen in the recruitment of the big banks, which over the past 30 years have gone from recruiting traders to setting up manual operations on a trading floor to now hiring IT assistants and technical teams. Today, many financial services companies prioritize hiring people based on their knowledge of computer systems and networks rather than their financial background. This has created a technological revolution, where these robots and algorithms have so much power in 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 skill of these systems has become so advanced that they surpass humans in almost every way. With financial markets being highly quantitative, AI has grown in popularity for a number of reasons. Split-second processing power and the absence of human emotion allow these robots to make informed, high-quality decisions faster than entire teams of experts in the field. Therefore, large funds are willing to invest heavily in the algorithm that will give them the best return.

For example, ALADDIN (which stands for Asset, Liability, Debt and Derivative Investment Network), an AI-based wallet system owned by BlackRock, the world’s largest asset management company, manages over 21,000 billions of dollars. To put that into perspective, the total US stock market valuation is around $100 trillion, making this algorithm hold over 20% of the total US stock market. This is because its software is licensed to other top asset management firms, such as Vanguard and State Street Global Advisors. This is of particular concern due to the fact that companies like Vanguard manage large numbers of people’s retirement 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 capital in the financial markets, one could argue that they have the ability to manipulate the markets in any way they want. Having the power to decide where capital flows gives AI the ability to choose who wins and who loses. This can be a problem as it can overpower the merit of a company itself. Instead of the market as a whole backing successful companies for long-term future growth, AI bots can drive up individual stock prices for short-term profit. This is also true for those who lose; If 20% of the market were sold in a short time, wouldn’t that lead to a major stock market crash?

Now there are counter-arguments, in favor of AI systems and management networks. First, it can provide greater sustainability because assets are spread evenly across a variety of financial markets. Continued support through large funds allows market liquidity to remain constant, enabling sustainable market performance. Many of these funds have close ties to regulators, central bankers and politicians. Although it may have negative connotations, a positive argument can be made for durability and protection. Investors can feel a sense of security knowing that they have substantial funds to support their investments and keep their retirement account(s) stable.

Moreover, the 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 is well known in the trading industry for the expert advice it offers to individual investors from all walks of life. Samuel & Co Trading has gained a strong reputation and wide following due to the variety of algorithms available, across a variety of different financial instruments, with a proven track record of delivering high performing returns. They recently released a Volatility Index Algorithm (VIX), which aims to capture volatility movements in the markets, allowing individuals to diversify their portfolio away from other traditional asset classes. As you can see, the influence of AI and algorithms on the markets can also benefit investors around the world.

Overall, whether the influence of AI in the world of trading and financial markets as a whole is positive or negative; influence is unlikely to change. Only time will tell what the long-term consequences will be. What we know right now is that algorithms have completely transformed every aspect of financial markets and it will likely continue to happen. We can reasonably expect that as computing power increases, the dominance of AI for asset management and stock market performance will also increase. Many of these AI systems are used by both large funds and individual investors. This means that the market is constantly on the lookout for new, innovative algorithms to not only diversify its portfolio, but also outperform the rest of the market.