For anyone paying attention to the news today, it may be impossible to ignore the stories about the emergence of artificial intelligence (AI). Some will know that AI is not a new development. Indeed, the first papers about machines having the potential for human-like intelligence surfaced as far back as the 1950s. What we are seeing today is simply a manifestation of the truth that AI technology has finally reached a point of mass adoption made possible by affordable deployment.
How does this apply to retail investing? Well, no industry or sector in the world of business has been untouched by the recent rise of AI. The applications of emerging AI tools are endless and will have far-reaching repercussions on how humans live and work. Investing, with its reliance on data and information, is a prime candidate for AI development. In this article, we will discuss the role of AI in retail investing.
What is AI?
AI is a field of study that combines computer science and powerful datasets to enable problem-solving. AI can also be defined as a machine’s ability to carry out the cognitive functions we usually associate with human minds. In today’s information age, with the endless rise of ever-cheaper and more powerful computer storage and processing, advances in AI will only continue to grow.
AI has the potential to vastly change the financial industry. If you think about it, at a basic level, trading is simply about manipulating large amounts of historical data to decode trends whose inference can be used to make information-base future bets. AI can help predict future trends with more accuracy. Using existing trading strategies, traders can use AI tools to improve the accuracy of their trading strategies. Powerful algorithms can identify patterns and automate financial tasks.
If you are an experienced investor reading this, some of this information will lead you to think that AI has already entered the investing field. You are correct. AI is not completely new in investing, as robo-advisors and expert advisors have been around in the trading world for a few years. This is AI at work.
How is AI Impacting Investing?
As we have said, AI is already active in financial markets. The only difference with the much-publicized rise of AI is that its applications are set to penetrate areas of investing it had not previously reached.
AI is already being applied to financial instruments to recognize patterns in the movement of FOREX pairs and make predictions about future movements. Think of it this way – today’s traders are encouraged to stay abreast of macroeconomic and political moves for the purpose of staying atop the markets. Imagine if you could train a machine to recognize patterns in historical trends and then use this knowledge to make predictions about future movements. It has already started happening and will continue to do so, except that more powerful and purpose-built AI tools will allow you to be much more precise about what news you want to pay attention to and how to use the information the AI generates.
Surely this means that all a trader’s problems are now solved and they can outsource all their trading strategies to AI tools? Unfortunately, this is not true right now and will not become true for the foreseeable future. For the purposes of this article, we asked the popular AI tool ChatGPT what the future of the USD versus the EURO currency pair would be. This is how it replied:
“As an AI language model, I don't have real-time data or the ability to predict future movements in currency exchange rates. The foreign exchange market is highly complex and influenced by numerous factors, such as economic indicators, geopolitical events, monetary policies, and investor sentiment. Predicting currency movements with accuracy is extremely challenging, even for financial experts and analysts who dedicate significant time and resources to such predictions.
If you are interested in forecasting currency exchange rates, it is best to consult with a financial professional or use specialized tools and resources specifically designed for currency analysis. These professionals and tools can take into account the latest market data, trends, and factors that may impact currency movements.”
So, out of the mouth of ChatGPT comes the truth – humans still have a large role to play in crafting investment strategies and harvesting the right information and deploying it in the best manner. AI will assist in making predictive and analytical tools more accurate and faster to operate, but humans will still drive what data goes into these models. Even so, you are not compelled to take the advice of an AI even when it offers it to you!
How Can AI Be Used in Investing?
AI is already making strides in affecting online investing in such asset classes as FOREX, stocks, bonds, commodities and cryptocurrencies. Here are some popular tools, new and old, that show how AI is impacting retail trading:
Algorithmic Trading: Using the enormous computational power available to today’s businesses, software developers have computer programs that can identify long-term patterns and be programmed to automatically carry out trades on your behalf. Using a combination of indicators and tools, they can make data-driven predictions of the prices of different currencies in a way that benefits you.
Pattern Recognition: AI uses sub-operations, such as machine learning and deep learning, that are deployed to reliably recognize patterns in financial markets. By analyzing historical data, AI models can identify recurring trends and use them to predict future market movements. Using this impactful data, traders have a better chance of making profitable decisions.
Sentiment Analysis: By powerfully aggregating information and news events, AI can arrive at informed positions that are based on broad market sentiment containing important information, like central bank announcements or GDP figures.
Risk Management: AI can help you identify and mitigate the risk of trading decisions. In the rush to start trading and make profits, many new investors move along with no heed to the dangers of trading. With trading risk management, you can implement clear rules to make sure that the negative effect of every trade is managed. As with every strategy, you need to plan ahead and know what you intend to do before you start trading. AI is very helpful in setting these boundaries.
Personalized Recommendations: AI-powered systems can be programmed to provide traders with highly specific, personalized investment recommendations. By studying a trader's risk tolerance, as well as investment goals, AI tools can offer suitable investment opportunities tailored to the trader's needs. This is to say, a trader could input some of their own preferences into the mix. A trader can still customize what goes into, for example, trading signals, by inserting considerations such as how far back to look, and even how much complexity the signal must include.
Automated Portfolio Management: AI-driven robo-advisors can manage investment portfolios for retail traders. As we have said, your risk management strategies are as personal as your portfolio. It all depends on your interests, preferences and experience. You cannot find a ready-made risk-management package. You still need to customize the best combination of risk management strategies for yourself.
The Pros and Cons of AI
There are several benefits of using AI in finance, but there are also major pitfalls you need to pay attention to. Here are some of the pros of cons of AI-based trading:
Improved accuracy: AI can help to provide more accurate predictions about financial data, leading to better decision-making and more successful trades.
Passive trading: AI can implement a more passive and automated approach to financial speculation. Time is a valuable commodity in every walk of life. By automating all the processes involved in trading, from analyzing charts to executing trades, AI tools free up your time so that you can focus on other important things.
They never tire: Financial markets are open 24 hours a day, five days a week. You can seek out balance and pursue your other needs and desires.
Can be customized to meet trader’s needs: You can customize AI tools to cater to your needs. You can keep refining the AI tool’s parameters until it works the way you want.
Enhanced Data Analysis: AI can analyze vast amounts of data much faster and more comprehensively than humans. It can process a wide range of financial and non-financial data, including historical prices, news articles, social media feeds, and economic indicators. This enables AI to identify patterns, correlations, and hidden insights that can inform investment decisions.
Better decision-making: By stripping the emotion from trading, traders can make more informed and data-driven decisions. AI models can analyze complex market dynamics, historical trends, and real-time data to generate insights and predictions.
Highly efficient: AI tools canmake instantaneous decisions. They do it by assessing multiple different input factors from the financial world to make rapid decisions every time – humans cannot compare. This eliminates human biases and emotions from the decision-making process and allows for faster trade execution.
Faster backtesting: You can test possible trading strategies using historical data and deploying the findings to create an optimized strategy. It can be difficult manual work, but AI tools can store and analyze vast troves of past data, giving traders the opportunity to test the effectiveness of different strategies before they hit the live market. You can take advantage of short-term price movements, react quickly to market changes, and implement trading strategies with minimal delays.
Remember, though, that AI may offer significant benefits, but it cannot guarantee success in investing. Even the best AI tools have limitations. With the rush to deploy AI in all industries continuing, there is a chance that suboptimal AI tools can enter the market. You must consider other factors, such as market dynamics and fundamental analysis in your decision-making process.
Of course, no tool is perfect, and AI tools are no exception.
Black box risk: Many AI algorithms are so complex that all but the very software designers who created the algorithms will struggle to know their inner workings. This means that if inferior data or biases entered the algorithm, they can lead to poor decision-making.
Overfitting risk: Otherwise known as data-mining bias, this occurs when an AI algorithm is trained on a limited set of data, leading to favorable results that grab the attention of would-be buyers, but for flawed reasons. This can lead to inaccurate predictions as the algorithm is based on its original context only.
Data risk and privacy risk: These significant concerns come with AI tools deployed in finance. There is the risk of security breaches. AI systems, like any technology, can be vulnerable to cyber-attacks. That is why it is important to take security measures seriously and ensure that your AI system is properly secured to prevent any data breaches. Most times, your broker will handle the safety aspect of any AI tool they provide to you, but if you choose to work with a third-party AI tool, you should investigate its safety stance closely.
No guaranteed returns: Regardless of the claims many AI developers may assert, you simply cannot promise guaranteed returns when trading the financial markets. The opposite could happen, and you could lose money.
Ways to Mitigate Risks
To mitigate the risks associated with using artificial intelligence in investing, you should use multiple data sources to test your system. This way you can identify any errors or biases in your model. As the industry is moving so fast, traders must keep up to date with research that can help them understand the latest and most effective AI techniques. As we have said, some of the biggest pitfalls of AI tools include:
Over reliance on historical data.
Model biases and errors.
Bad or limited data.
Now, it is not reasonable to expect the average trader to be able to pick these errors up from the code lines of AI tools; but rather, you should watch out for the results. Keep testing your AI tools. Don’t simply buy them and blindly deploy them without tracking results versus your previous methods.
Biases can lead to flawed predictions, inaccurate investment recommendations, or discriminatory outcomes. You must monitor and regularly update your AI tools to the latest versions. Remember also that all technology has limitations and there could be technical glitches, errors and vulnerabilities. Never rule out the chance of data breaches and even scam activity that could derail your portfolio.
Finally, keep an eye on regulatory and legal challenges. Many people agree that AI tools will make our lives easier and more efficient. However, some insiders, including influential regulators, are preaching caution. It is not out of the question that regulators could put in place serious guardrails around the use of AI tools in the near future. This could impact its application in investment activities.
It all comes down to the same types of advice most traders hear all the time. You must keep abreast of developments in this space and not believe all the hype. Conduct your own research and even backtest your strategies. As powerful as AI tools can be, they are still administered by humans who are fallible and can make mistakes.
AI tools can augment your investment decision-making, but it should not take it over completely. Even after combining AI-driven insights with fundamental analysis and market knowledge, the value of your human judgment will never go away.
The Future of AI and Investing
The future of AI in financial investing should be thrilling to everyone within the ecosystem. It is notunreasonable to expect a significant shift in the way brokers operate. AI will help to streamline many of the repetitive and time-consuming tasks that currently require human intervention.
AI tools will enter trades without the need for human input (after it has received its initial instructions). Already, this is a massive advantage to busy human traders who often do not have the time and energy to trade actively all day long.
The good news is that many AI tools, such as robo-advisors, are already successful. They need to be created by a reputable company, and they should be deployed as intelligently as possible, within their limitations. Remember that AI tools are not watertight and, therefore, cannot guarantee long-term profits for everyone.
How to Get Started
If you are going to make AI a key part of your investing strategy, it is important to try to understand the underlying principles, limitations, and potential risks of AI-based tools before incorporating them into your investment strategy. Remember, your broker will already have a company stance on AI tools, as every responsible firm is going to great lengths to understand how to position AI tools in their product slate.
Here are some steps you can take to leverage AI in your investment activities:
Research AI-powered platforms: Some brokers are already providing helpful AI educational resources, such as Webinars or explainers. This is a good place to start when you begin to do your research. Depending on your broker, you could have a dedicated resource, such as an account manager who could speak to you directly or refer you to an in-house subject matter expert.
Explore robo-advisory services: These have been around for some time, but now might be the perfect time to seriously investigate AI-powered robo-advisors to manage your investment portfolio on your behalf if you are not already using them.
Learn more about AI-powered indicators: As we have said, you must educate yourself about AI-based indicators and trading strategies. This may be via your broker or via your own research.
Find out about third-party AI tools: Some third-party software providers offer AI-based tools that can be integrated with popular trading platforms. These tools may provide features like pattern recognition, sentiment analysis, or automated trading strategies. Explore such tools and check if they are compatible with your broker’s platform.
Be prepared to experiment: Once you understand the basics, you can start trying the many AI tools on the market. Again, for practical purposes, you may have to stick to what your broker can offer, but if they have not joined the AI revolution, then you may have to look elsewhere. See how the tools work in practice and find out what works for you.
The Bottom Line
AI tools can powerfully enhance your investment decision-making. However, it is always good advice to keep a well-rounded approach to investing. Remember to combine AI-driven tools with fundamental analysis, risk management, and your own experience and judgement to make the best investment decisions that agree with your financial objectives and risk tolerance.
AI tools are here to stay. As exciting as their potential is, there is still a lot of work required to get them to a point where they are universally reliable. Even then, the need for sound human discernment will never go away.
How does AI affect decision-making when investing?
AI tools can augment investment decision-making by studying large masses of data, finding patterns, and producing useful information. You can use the tools to automate your trading strategies, get personalized recommendations and generally keep your risk profile lower.
Can AI tell me what the future of a financial asset will be?
Not exactly. AI tools are by their nature backward-looking as they study historical trends. Using these trends, AI tools can, at best, give you insights and predictions that are likely to be more useful than taking a wild guess. No tool can ever predict the future and actual events can vary significantly and unexpectedly from the past.
Is it better to go with AI than to stick with old-school methods?
Old-school investing was mostly manually, driven by human traders. The benefit was that humans became steeped in their financial portfolios and could make judgement calls from a deep place of understanding. However, AI-driven trading strategies can offer serious advantages, such as faster and more accurate data analysis that can alleviate a lot of the manual work, freeing you up to do other things. On balance, most experts would recommend that you automate some elements of your portfolio.
Should I use robo-advisors?
AI-based robo-advisors have been around for some time, even before it was fashionable to call something AI-driven. They have a proven record of providing cost-effective and automated portfolio management services and are a good option for hands-off traders.
How can I get started with AI tools?
Retail traders should start by approaching their broker to ask them what they can offer in the realm of AI tools. You must research available options, consider your specific needs, and choose the best platforms that offer AI-driven features.
Can AI help me find rough diamonds or undervalued opportunities?
Yes. Every market has areas of unmined value. Truth be told, you can find rough diamonds with a human-only trading approach, but using AI tools just helps you get there faster.
Is AI investing ethical?
In general, it is considered broadly ethical to use AI as an optimization tool in financial investing. Some ethical considerations come into play when considering how firms choose to develop, deploy and publicize their AI tools as there is potential for biased models, algorithmic “fixing,” and lack of transparency.
Adrian Ashley is a seasoned business and finance writer. With a corporate career spanning over 20years, he has developed deep experience in such diverse areas as investing, business, finance,technology and macroeconomics. He is passionate about captu...