Thursday, January 15, 2015

Artificial Intelligence in the Stock Markets

Artificial intelligence has been much in the news recently.  Well-recognized deep thinkers have propounded profound thoughts that predict good and bad outcomes for artificial intelligence as it becomes ever more of a reality.  The takeover of the world by machines is inevitable--with monstrous consequences--or not, depending on who you ask.

There isn't much real-world empirical data relevant to the opposing sides of this argument.  But one big clinical trial is underway:  in the stock markets.  Most of the trading done today in the stock markets consists of computerized trading.  Institutional investors, like mutual funds, pension funds, and so on, comprise most of the rest.  Mom and Pop, trying to invest a few nickels for their retirement, are like pedestrians surrounded by massive semis barreling along at interstate speeds.

Much of the computerized trading is done by dynamic computer programs.  In other words, the computer doesn't buy and sell based on a static algorithm embodied in the program coding.  The program can change itself in response to market conditions and activities.  In essence, depending on what the program detects is happening in the market, it can alter its own coding without the need for a human programmer to keypunch and proofread line after tedious line of code.  The details of how these dynamic programs work are generally shrouded in commercial secrecy.  But we have a situation where computer programs take note of what's going on in their working environments, think about how to change themselves to be more effective (i.e., profitable) in light of changing conditions, and then alter themselves to do better.  That's getting rather close to what people do: try to change and improve themselves in order to advance their careers or make more money in their professional activities.

We have seen in recent years how computerized trading can cause mini-crashes and other short term  turbulence in the stock markets.  Mom and Pop are often finding the waters too rough, and suddenly see the virtue in the paltry returns of passbook savings accounts or certificates of deposit whose yields have been flattened by the nearly supine yield curve.  Even some professional money managers are looking for ways to fly over or around the storm clouds of computerized trading, moving trading to venues that claim to allow only "natural" (non-computerized) investors to participate.

For academic researchers and other prognosticators, the dynamic computerized trading in the stock markets could furnish a useful body of data with which to work.  The rest of us, unwilling guinea pigs in a clinical trial we didn't sign up for, can only look to financial regulators and other government officials to ensure that the results of the experiment don't turn out too badly,

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