The 2020s have seen artificial intelligence (AI) become one of the most trending topics, not only in the tech community but in every domain undergoing growth. It has revolutionised the way we interact with things, both on microscopic and macroscopic levels. For example, you may have definitely used your AI assistant like Google Assistant, Alexa, or Siri on your phone to set reminders, help you navigate, and educate you on particular topics. Likewise, mega-corporations use AI to transform their business activities to improve efficiency and optimise production.
The financial sector is no exception, and AI has penetrated this space as well. If we focus on stock trading activities, AI is playing an important role in taking algorithmic trading to the next stage. In this article, let us understand the role of AI in algorithmic trading.
Table of Contents
What Is Artificial Intelligence?
Before we look at AI in algo-trading, it is essential that we take a look at what AI actually is. It is important to clarify a few things surrounding AI since, despite its popularity, many people find it a convoluted subject. Due to the technicality involved, many people fail to comprehend the term AI.
The term artificial intelligence was coined by the American computer scientist John Macarrthy. To put it plainly and simply, AI is the intelligence shown by a machine. So, AI uses traits like reasoning, planning, learning, and problem-solving to reach certain conclusions. For example, Google Assistant qualifies as AI as it portrays the ability to reason, learn, and solve problems like a human to some extent. So, do not confuse AI with machine learning, which is an application of AI that allows machines to learn from data. It is the process of extracting knowledge from available or imputed data.
Trading, Algorithms, and Robots
Stock trading has also come a long way from the days of exchanging physical certificates, and this was before AI penetrated this domain. From physical trading, we moved to online trading, and now we are moving towards algorithmic trading. Algorithmic trading is the process of conducting trades with the help of computer programs. Computer programmers work in tandem with mathematicians and statisticians to design algorithms to execute various trading strategies. Studies from 2018 show that around 80% of trades in the US markets were algo trades.
Algo trading, too, continues to evolve with time, and the AI in algo trading has given rise to trading bots, sometimes simply referred to as bots. The implementation of trading bots has made high frequency trading a popular trading method among institutions. Institutions and brokers rely on algorithms and trading bots to make transactions. That is because algorithms and trading bots make it possible to trade in the markets at a high frequency with small spreads. No longer do they place their orders manually. So institutions and professional traders look for the best systems to run the best computer programs.
Benefits of AI in Algo Trading
Stock trading or security trading, at its core, is the process of analysing data, making decisions and staying disciplined to make profits. To elaborate, a trader may analyse price charts, identify distinct patterns, and compare them to similar patterns in the past. Based on that, the trader develops the ability to predict where the price is heading next. They construct a strategy around that, and follow it to make profits. Now that you understand the process of trading, let us see how AI in algorithmic trading can help improve efficiency when it comes to trading.
Scan Multiple Charts
Starting off with the benefits of AI in algo trading, let us understand how AI can help with analysing data. There are several thousand listed companies in the world. As a human trader, you can only restrict yourself to a few geographies, and scan only a few price charts on any given day. However, bots and algorithms can help traders find the best trading opportunities across multiple geographies and exchanges. That is because trading bots can scan multiple price charts within a few minutes.
Instant Trading
Algorithms and AI trading bots can scan multiple charts and identify favourable conditions. Then, when the algorithm detects a favourable condition, it can place huge trading orders and execute them within seconds. This type of trading is called high-frequency trading, generally abbreviated as HFT. In contrast, our human fingers are incapable of placing orders at that speed. AI helps with the automation of the entire process of buying and selling securities.
Eliminates Human Error
Lastly, algorithmic trading also helps maintain discipline, by virtue of sticking to the trading rules designed around the strategy. Suppose you are a trader using your trading app on your phone to make transactions. At some point in your trading journey, your emotions influenced your decision making. The emotions of fear and loss may have prevented you from making buying and selling transactions.
Algorithmic trading solves these problems, as your emotions do not interfere with the algorithms making the trade. The algorithm is quick to execute transactions, just like it was programmed to do. AI can help the computer adjust instructions and execute the most suitable strategies for different market environments. So, AI in algo trading helps with finding opportunities and executing them in the best possible manner.
AI in Algorithmic Trading Today
So, like we read, artificial intelligence has helped revolutionise different spheres, and the trading sphere is no different. AI has helped bring algo trading to the stage. Today, all the top global financial giants like Morgan Stanley and JP Morgan depend on AI in the algo trading strategies they implement. India’s adoption of algorithmic trading is becoming a thing, and the top Indian Financial Institutions have also started using AI to make their trades more efficient.
