Artificial intelligence (AI) is the simulation of human intelligence by machines. This is accomplished by software that attempts to replicate a human process. While artificial intelligence can entail very sophisticated applications, such as OpenAI’s ChatGPT (which can converse with users) or autonomous driving applications, artificial intelligence encompasses a very wide range of applications. One term often associated with financial market artificial intelligence is algorithms, which refers to a set of programmed instructions that provides results from the data analyzed by the program. Artificial intelligence in investing and finance takes many forms, some of which are relatively straightforward.
Hedge funds and other trading operations utilize artificial intelligence at a very high level to, as an example, gain the slightest advantages in fast-moving markets. But artificial intelligence is also widely used in finance and investing because of its ability to process and analyze information from very large data sets. Further, artificial intelligence can be used to help choose stocks, make predictions on market movement, optimize portfolios, manage risk, obtain personalized investment advice, manage trade entry and exit strategies, and automatically build a customized portfolio that meets specific investor criteria like risk tolerances. We will discuss a variety of ways any investor can incorporate artificial intelligence into their investing.
How to Use Artificial Intelligence in Your Portfolio
Here are some ways regular investors can utilize artificial intelligence in their portfolios.
Stock Picking
All of the companies that trade on U.S. stock markets have many data points that investors can use to determine what stocks they want to buy or sell. Artificial intelligence allows investors to efficiently sort through this data to identify stocks that meet their criteria. Stock screeners are sophisticated tools that allow investors to filter stocks on criteria that can include fundamental and technical data points, such as accounting ratios, market capitalization, trading volume, and moving averages, to name just a few of the literally hundreds of data points available. If you’re looking to get started with a stock screener, consider learning how to use these platforms by starting with one of the many free versions that are available, like ZACKS (NASDAQ).
Automated Portfolio Building
Robo-advisors like Wealthfront and Betterment automate the traditional process of working with an advisor to outline investing goals, time horizons, and risk tolerances in order to create a portfolio that meets the needs of the investor. Automated portfolios guide the user through a questionnaire that then scores to a model portfolio that meets the criteria of the investor. In addition to the questionnaire and the scoring of models, these platforms also use artificial intelligence to determine the optimal mix of individual stocks for the portfolio. Further, automated portfolios are also set to automatically rebalance if the target allocations in the portfolio drift too far from the selected portfolio.
Trading and Trade Management
The ability to trade markets in near-instantaneous time, and strong computing power, has resulted in brokerage companies providing customers with very sophisticated order entry tools that allow computers to monitor trade entry and exit. This order management can be very sophisticated, but an example would be using tools to purchase a stock if it meets one or multiple criteria set by the user, then manage an exit strategy that could entail a conditional order such as using a stop or profitable level to exit a position based on what the market does. The diligent use of AI for trading and trade management, if used properly, can greatly reduce the emotional aspect of trading. This article on trading psychology discusses why dealing with your emotions is important for traders and investors alike.
Portfolio Optimization
AI is a good tool for portfolio optimization. It enables investors to identify a portfolio that fits their specific needs relative to risk tolerance and time horizon. Further, once a portfolio has been selected, AI can be used in conjunction with modern portfolio theory to craft a portfolio of stocks that falls on the efficient frontier, which increases returns relative to risk.
Data Interpretation and Predictions
The idea is to develop AI algorithms that allow a prediction about where a stock or other security will go for the purpose of making a profit. While many develop algorithms using AI to make trading or investment decisions, not all models are correct. Active money managers are trying to outperform the general market indexes, and some do, while others do not. If you believe that cycles repeat, for example, you might utilize AI tools to identify these cycles. Order entry based on a technical analysis tool is another possible area where AI could help make automatic entries and exits.
Risk Management
Various risk management techniques have been discussed, such as using AI in conjunction with modern portfolio theory and the efficient frontier, and using sophisticated order options to manage risk on active trades. However, AI can also be used to reduce over-exposure to individual stocks in a portfolio (such as when multiple managers all have the same stock in different asset classes in the same portfolio), or to establish automated options strategies to assist with risk management.
How Robo-Advisors Use Artificial Intelligence
Through automated portfolio building, robo-advisors automate the traditional process of working with an advisor to outline investing goals, time horizons, and risk tolerances in order to create a portfolio that meets the needs of the investor. Automated portfolios guide the user through a questionnaire that then scores to a model portfolio that meets the criteria of the investor. In addition to the questionnaire and the scoring of models, artificial intelligence is also used by these platforms in order to determine the optimal mix of individual stocks for the portfolio, which is often accomplished using modern portfolio theory. Further, automated portfolios are also set to automatically rebalance if the target allocations in the portfolio drift too far from the selected portfolio.
Steps Needed to Use Artificial Intelligence in Your Investing
As we have illustrated, AI in investing encompasses a lot of tools that can be used by professional and individual investors and traders. If you want to incorporate the use of AI into your investing or trading, you may consider taking the steps that follow.
Step 1: Understand Your Financial Goals
The first step is the same for every investor, which is to understand your financial goals so you can move forward with an investment strategy that fits your needs.
Step 2: Choose Your Investing Method
Next, you need to determine whether you will be using a robo-advisor that does much of the work, or investing on your own. If you go with a robo-advisor, the advisor’s AI technology will be doing most of the heavy lifting. This entails the questionnaire, model proposal, and the management of the portfolio.
Step 3: Select an Investing Strategy
Those making their own investment decisions should determine their investing strategy to understand the types of stocks they want in their portfolio. Investors could also utilize suggested models from robo-advisors, often available for free, to help determine the mix of asset classes for their portfolio. This is using AI to help set a strategy that will be individually managed.
Step 4: Identify Your Investing Tools
For those making their own investment decisions, stocks screeners would likely be helpful AI tools when choosing the individual stocks for your portfolio. Stock screeners often have pre-set screens to help get the user started in filtering for stocks to consider.
Step 5: Start Managing Your Portfolio
Once the portfolio is up and running, investors may want to utilize automated tools to help manage their positions for entry and exit points. They may also want to consider further refining their stock screen searches and learning how they can use the efficient frontier to craft a portfolio built for both favorable returns for the lowest level of risk possible.
What Is Artificial Intelligence (AI)?
Artificial intelligence (AI) refers to the use of machines to simulate human intelligence. AI is accomplished by computers and software, and uses data analysis and rules-based algorithms. It can entail very sophisticated applications and encompass a very wide range of applications. Artificial intelligence in investing and finance takes many forms, but the tremendous amount of data available on financial markets and financial market prices provides many opportunities to apply AI to investing and trading.
What Kind of Financial Data Is Analyzed by AI?
Just about any financial information can be analyzed by AI. This includes fundamental data, such as a company’s earnings, cash flow, and any other data that may impact the stock’s price. This article, What are Stock Fundamentals?, provides more information on what fundamental data is and how it is used. Artificial intelligence is also used in technical analysis tools, which include data related to the number of shares traded, and other mathematical criteria related to past price activity.
Is Investing With AI Suitable for Beginners?
Absolutely, AI is suitable for beginners! Robo-advisors are often the first step for beginning investors, and these platforms are heavily reliant on AI. While some artificial intelligence represents cutting-edge technology and the ability to understand and process language, plenty of it is much more intuitive. In investing, such as stock selection, AI allows investors to filter stocks that meet their criteria much more simply through stock screeners. These screeners apply the same intelligence as an individual would, but they can do so much more quickly, efficiently, and accurately than a human. Any investor, even a beginner, would benefit from these powerful and easy-to-use stock screeners, as well as other AI investing tools.
Is Investing With AI Safe?
It is safe to use AI, but AI applications for financial markets are only as good as both the quality of the AI application and the ability of the individual to use the application. AI tools for financial markets can be used to identify risky or safe stocks, so the relative safety is a function of the choices the investor makes related to risk and reward of different stocks. Using modern portfolio theory to find a portfolio of stocks that maximizes gains while minimizing risk is another safe tool to use in making investing decisions. Faulty algorithms, and the potential for moves related to large numbers of investors using the same AI-generated information, are potential risks with using AI for investing.
The Bottom Line
Whether you know it or not, the link between AI and investing is here to stay. Even if you are not directly using AI yourself, portfolio and fund managers all utilize AI in multiple ways, and your investment advisor is likely also using the same tools robo-advisors use to help determine risk tolerances and the best portfolio for their clients. Fortunately, AI tools for investing are now widely available to individuals.
If you are a hands-on, active investor, you will be using AI in more than one way to manage your portfolio, make decisions on purchases and sales, and manage trading positions, so it is important to understand and keep abreast of developments in the AI and investing space. Investors should, therefore, look at the various investing tools that use AI on their existing platform to ensure that they are sufficient for their needs. If not, investors may want to consider either a different broker with more robust AI investing tools, or supplementing their broker platform with third-party AI investing software; an example would be using a separate stock screener for choosing stocks.
