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 a 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. 

 

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.

LeackStat 2023