You know, when I wrote Friday’s article, I wasn’t planning at all to get into a discussion about artificial intelligence in trading. I was just pleased with the notion that institutional program trading would either (1) never lock out the little guys and gals, or (2) trading would cease to serve its economic function, and would be replaced by something else. Other than an offhand statement that amateurs may be using super-fast AI agents one day, that part of the topic just wasn’t on my mind.

But, Ugly came out almost right away to remind me about the likelihood of eventual computer trading agents that surpass humans in trading ability. The way software tends to go, once that’s anywhere, it will be everywhere soon after. When the bar for the amateur trader is raised, you need to make sure you’re still on the right side of that bar!

Current program trading, to the best of my understanding, is mostly filling complex orders on behalf of humans, at the behest of humans. Then there are the quant funds, which at present occasionally still spaz out. I would expect both of these to continue to get more sophisticated, but they really aren’t in direct competition with the small daytrader.

Look around, though, and you’ll see that more and more scalping black-boxes are coming on-line. They are not too impressive right now (though they at least make a profit, which is admittedly better than most human traders manage to do). These mechanical trading systems will also improve over time, but they still aren’t quite what I think of when I picture the trading agent of the future.

AI Trading Agents

I don’t know what you picture when you think of these hypothetical advanced trading agents. I can tell you what I imagine. I imagine a discretionary trader just like myself, with notable exceptions:

• it spots opportunities faster
• it acts upon those opportunities faster
• it does so across multiple markets, simultaneously, 24 hours a day
• it never trades out of boredom, or revenge, or desperation
• it has a perfect memory of past events and performance, which it can use to continually learn and improve
• …you get the picture by now, I hope

In short, it has more of every quality that I think makes me a good trader. I would kill to have these qualities. As the percentage of traders with these qualities increases, I would expect my trading expectancy to decrease. At some point, my expectancy would drop to 0.

Is it really so hard to see why that is? You can readily see it in today’s markets. If you press the buy/sell button too late (or are too far back in the order queue), you either get filled at a worse price than you wanted or you don’t get filled at all. When you are filled at a worse price, your potential profit decreases, while the risk you take on increases. Your expectancy drops. And that’s assuming all of your analysis was correct, and the order wasn’t fat-fingered, etc. etc. Every time I try to trade while groggy or sick, I make less money. Hell, every time my internet connection gets a little laggy, I make less money. There’s not much room for error, even today.

There are people who conjecture that as a group of faster, smarter traders eats up the opportunities you have now, they will create new opportunities for profit in the process. Do you know who I would expect to find and exploit those new opportunities first? The smarter, faster traders, that’s who. Leaving me in the dust yet again.

There’s nothing special about the fact that we are talking about computer programs… I would expect the same result if I were slower and dumber than most other human traders. Since I don’t seem to fall into that category, based on my performance to date, I don’t fear human traders. But look at the progress of computers in cognitive and creative areas, though… something would have to stop the trend they’re on to keep them from catching up with me and then surpassing me.

I don’t know what that barrier would be, that can stop the progress of technology. I feel it’s safest to assume the trend will continue.

It Only Gets Harder

Up to now, we are mainly talking about computerized trading agents that are somewhat better than good human traders. If you fast-forward a bit, it gets much worse for the poor unassisted human. You see, as computers continue to gain speed and cognitive ability, the divide between them and plain old humans will continue to widen. So maybe earlier you felt like a high school basketball player playing in an NBA game. If you are one of the few very talented, you could probably still compete. Eventually, though, you will feel like my cat playing in an NBA game…. fearful of all the strange action and unable to comprehend what’s really going on.

I can imagine a future market where the only exploitable edges left have more features to consider than the human brain can easily process at once (see any cognitive psychology textbook for more about these limitations). At this point, the unassisted human literally cannot identify the opportunities in time to take advantage of them.

Doesn’t this raise computers into some sort of Magical/Mystical object?

I was really surprised when I saw this claim on Ugly’s comment section. The AI perspective is that there is nothing unique or special about human intelligence, and that its underlying mechanisms can be emulated and improved upon. To claim computers cannot duplicate human intelligence raises the human brain into some sort of magical/mystical object, as far as I’m concerned.

But Unlike Current AI Conquests, the Markets Are Always Changing…

Yeah, and chess is harder than checkers. And poker has more human elements than chess. The next step is always more complicated than the last step, every step of the way. And yet, progress is still accelerating. I mean, the software credibly challenging poker experts today runs on a cheap Apple laptop…

To me, wars and other news events are elements that make the markets hard for everyone to navigate. I guess, the people harping on this are coming from the perspective that humans currently have the advantage when adapting to unforseen elements. If you believe that intelligence on par with humanity can be duplicated, then it must be obvious to you that this will not always be the case.

But, The Markets Aren’t a Problem with a Solution

They don’t have to be. Software exists that is beyond problem solving via pre-set recipe. It has been around for a long time, in the ivory towers. In my opinion, it will become more mainstream relatively quickly. As cognitive and creative capability in software increases, computers will dynamically find and exploit opportunities based on the simple goal to make a profit. Just like I do. To claim that this is impossible makes my intelligence into something mystical and magical, and I just do not believe in that theory.

So, What Can We Do?

Keep up, that’s what. Like I said in Friday’s article, your goal is to stay at least one step ahead of most amateurs. The technology available to the small trader is getting more sophisticated all the time. Take advantage of it. Look at tools like trade-ideas, which help you spot all kinds of conditions in real-time, and their associated features to quantify which strategies seem to be working right now. Look at platforms like tradestation or multicharts that allow you to test and identify all kinds of complicated, cross-market cross-timeframe conditions. And on and on.

Learn some programming basics, so that you can offload as much of your analysis as you can onto your computer. Do this because more and more of your neighbors are doing it, and it’s making them faster and more accurate than you are. Slowly but surely, you will start to lose if you don’t.

Extrapolate far enough, and when most small players are autotrading, in my opinion it’s fairly easy to see that you had better be on board.

Where’s Your Proof?

There is no proof for any of this. I can’t prove that the sun will come up tomorrow, either. Like the magic 8-ball, I just know that all signs point to ‘yes.’ When you think about the future, you usually extrapolate from the present. In the recent threads, Ugly’s been kind enough to provide links to various current activities in this space. Even a little undergraduate work in AI will open up your eyes to what is possible, given time and processing power. This post is just my conjecture. You are free to reach your own conclusions.

Also feel free to leave either agreeing or disagreeing comments below. I certainly don’t have a lock on the future. The more the merrier. It’s fun to imagine the future of technology when the discussion is genuine and light-hearted. Last time, it got to the point that I sat through comments deconstructing my word choices. I will try my best not to participate in that level of discussion again–it frustrates and brings out the worst in me. Let’s try to be civil, and intelligent, this time. Thanks.

You know, ugly was probably the first one to point out to me this argument that computers will soon make human traders obsolete. But, lately I have been thinking that there’s no reason to be concerned.

Ever since I read The Poker Face of Wall Street, I’ve found it enlightening to look at all the various markets as gambling arenas. The book is very compelling in this regard. After all, if the stock market were really primarily for facilitating investment at fair prices, they could just collect all the buy and sell orders and process them once or twice a day at the fair market price (and that’s just one example from the book).

You know, they have a computer program that’s solved checkers (it plays perfectly). Would you bet money that you could beat that program? Neither would I. Would you buy a computer chess game if it didn’t have a crippled mode that you can actually compete with? Neither would I. You don’t hustle someone at a pool table by crushing them right away. Do you see where I’m going with this?

Any gambling establishment will tell you that they need a steady stream of amateurs coming through to keep the pros (and the house) fed. The book has a demographic breakdown of a poker house in one chapter, and it looks exactly like what I imagine the trading demographic is. A large number of people take money from their jobs and mostly lose it at the tables part time. Exponentially smaller groups play professionally at a subsistence level, and a tiny group gets wealthy. A system like that just doesn’t work without a steady stream of amateurs who think they have a chance of winning.

So, that tells me that the big players probably like the game just fine the way it is. They don’t want to collude to crush the amateurs in an obvious and spectacular fashion (and thankfully, I think there are enough big players that they would pretty much have to collude)… they would much rather bleed them dry slowly over time. And, they sure as hell don’t want to speed up/gap everything until it resembles the fabled “efficient” market, because no one can beat that game.

To me, this means that the trading game will always be easy enough for most amateurs to win sometimes. Specifically, they’ll be able to win often enough to keep them hooked. And that means I will always be able to make consistent money by making sure I’m better at it than most amateurs. That doesn’t mean that the game won’t change dramatically going forward. That also doesn’t mean that most amateurs won’t be trading with super-fast, artificially intelligent computer agents one day… but I have a feeling I’ll still be one step ahead of them, when it happens. :-)