AI-Based Trading is More Likely to Decrease than Increase Problems in the Markets

Futurist Thomas Frey has written an article suggesting that AI-based financial trading is a threat and is likely to cause a series of horrible market crashes....

This is a topic I've thought about a bit due to my being co-founder and Chief Scientist of Aidyia Limited, an AI-based asset management firm that will be launching a series of funds, beginning with a US equity long-short fund in a couple months.   Note that this is not a high-frequency approach -- our average holding period will be weeks to months, not microseconds.

So here are a few quasi-random musings on the topic....

Overall -- It seems clear to me that within a decade or two the financial markets will be entirely dominated by AIs of one form or another. Human minds are simply not well configured for the sorts of problems involved in asset price prediction, in such a complexly interlinked world as we have today.

However, I see no reason why AI-based trading would lead to worse crashes. Generally, when one creates an AI-based trading system, one does so with a certain mandate in mind, including a certain risk/return profile. IMO an AI that is well-done is more likely to operate within its intended risk/return profile, than a human trader.

Many of the trading disasters commonly attributed to quantitative methods are ultimately the result of plain old bad human judgment. For instance the Long Term Capital Management problem in the late 1990s did involve use of advanced quantitative models -- but ultimately the core of that problem was the use of leverage up to 100x, a choice made by the humans running the system not by the equations themselves. Common sense would tell you that trading with 100x leverage is pretty risky no matter what equations you're using. Having AI inside a trading system is not a total protection against the stupidity -- or emotional pathology -- of the humans trading that system.

The flash crash apparently was mainly due to automated systems, but probably not AI-based systems. Most HFT systems have minimal AI in them -- they're based on reacting super-quickly not super-smartly. The use of HFT shouldn't be conflated with the use of AI. HFT could be pretty much eliminated from any market by imposing a per-transaction tax like we have here in Hong Kong; but this wouldn't get rid of AI. Our AI predictors at Aidyia are currently being used to predict asset price movements 20 days in advance, not microseconds in advance.

But anyway...

As I've written previously in various places, I personally think the whole world financial and economic system is going to transform into something utterly different, once robots and AIs eliminate the need for (and relative value of) human effort in most domains of practical endeavor. So I view these issues with AIs and asset management as "transitional", in a sense. But that doesn't make them unimportant, obviously -- for the period between now and Singularity, they will be relevant.

I worry more about the ongoing increase of income and wealth inequality in nearly every nation, than about the impact of AI on the markets. Computers are already dominant on the markets, AIs will soon be dominant, but as long as the AIs are operating funds owned and controlled by humans, this doesn't really affect the nature of the financial system.  But part of this financial system is increasing wealth concentration -- and I worry that increasing inequality, combined with a situation where robots and AIs ultimately liberate people from their jobs, could eventually lead to a difficult situation.  I believe we ultimately will need some kind of guaranteed minimum income across the planet, the only alternatives being mass warfare or mass dying-off.  But I worry that the worse class divisions get, the harder this guaranteed-income solution will be to put in place, because the folks holding the remnants of human political and economic power will become more and more alienated from the average people.

So I do think there are lots of tricky worries in the medium-term future, regarding the relation between human society and (basically inexorably) advancing AI. But AI-based traders aren't really something to fuss about IMO.   I think that getting messy human emotion out of the mechanics of trading is more likely to decrease the odds of catastrophic crashes than increase it....  If you want to look out for dangers associated with the advent of AI based trading, I'd suggest to keep an eye out for more LTCM like situations where humans make egregiously bad emotional judgments in managing their AI prediction systems.   The AIs themselves are not likely to be the source of irrationality and chaos in the markets.