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Advances in AI may lead to undesirable outcomes for investors in the future.
As advances in AI speed up markets and create more complex trading models, many stocks may become crowded in search of alpha, and there is a risk of rapid downdrafts if information changes. Billy Hult, CEO of Tradeweb Markets (TW), warns.
“This is something we have to think about,” Hult told Yahoo Finance executive editor Brian Sozzi on the Opening Bid podcast (video above, listen here).
Crowded trading occurs when similar investment strategies, usually utilizing complex trading models, steer all investors into the same stocks. As bulls rush forward and little attention is paid to company valuations, the prices of crowded stocks tend to rise.
Lack of liquidity, spikes in volatility, and short squeezes are some of the risks associated with crowded trading.
Another risk is that if the information changes, the stock price could drop significantly and everyone could head for the exit all at once.
The latest example is the rapid market decline in early August.
Bank of America strategists said in a note at the time that “congestion risk is important,” with “the least crowded stocks outperforming the most crowded stocks by 8 percentage points.”
The Magnificent 7 tech stocks rose in popularity again this summer, as AI chip giant Nvidia (NVDA) enjoyed temporary status as the world’s most valuable publicly traded company.
Experts like Hult argue that this kind of concentration in high-performing stocks will get worse as markets become more sophisticated due to AI.
But AI proponents envision a world where traders are better informed through deeper insights gleaned from a variety of sources.
“I think data-driven execution is here to stay in fixed income trading, and we’ll continue to see machine learning applied to things like liquidity exploration in fixed income,” Hult said. . “The next level of technology will be even more sophisticated.”
Hult is a long-time evangelist for the integration of finance, investment vehicles, and innovative technology. As a builder of electronic markets, Tradeweb has worked with companies looking to combine investors and machines. However, the need for softer interpersonal skills remains the same.
“(Tradeweb) has been living and breathing the spirit of the market for a long time,” Hult said. “We really value the personal relationship aspect of our business.”
Three times a week, Yahoo Finance Executive Editor Brian Sozzi has insightful conversations and chats with some of the biggest names in business and markets on Opening Bid. Find more episodes on our video hub or watch on your favorite streaming service.
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