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ChatGPT-powered Wall Street: The benefits and perils of using artificial intelligence to trade stocks and other financial instruments

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ChatGPT-powered Wall Street: The benefits and perils of using artificial intelligence to trade stocks and other financial instruments

Markets are increasingly driven by decisions made by AI.
PhonlamaiPhoto/iStock via Getty Images

Pawan Jain, West Virginia University

Artificial Intelligence-powered tools, such as ChatGPT, have the potential to revolutionize the efficiency, effectiveness and speed of the work humans do.

And this is true in financial markets as much as in sectors like health care, manufacturing and pretty much every other aspect of our lives.

I've been researching financial markets and algorithmic trading for 14 years. While AI offers lots of benefits, the growing use of these technologies in financial markets also points to potential perils. A look at Wall Street's past efforts to speed up trading by embracing computers and AI offers important lessons on the implications of using them for -making.

Program trading fuels Black Monday

In the early 1980s, fueled by advancements in technology and financial innovations such as derivatives, institutional investors began using computer programs to execute trades based on predefined rules and algorithms. This helped them complete large trades quickly and efficiently.

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Back then, these algorithms were relatively simple and were primarily used for so-called index arbitrage, which involves trying to profit from discrepancies between the price of a stock index – like the S&P 500 – and that of the stocks it's composed of.

As technology advanced and more data became available, this kind of program trading became increasingly sophisticated, with algorithms able to analyze complex market data and execute trades based on a wide range of factors. These program traders continued to grow in number on the largey unregulated trading freeways – on which over a trillion dollars worth of assets change hands every day – causing market volatility to increase dramatically.

Eventually this resulted in the massive stock market crash in 1987 known as Black Monday. The Dow Jones Industrial Average suffered what was at the time the biggest percentage drop in its history, and the pain spread throughout the globe.

In response, regulatory authorities implemented a number of measures to restrict the use of program trading, circuit breakers that halt trading when there are significant market swings and other limits. But despite these measures, program trading continued to grow in popularity in the years following the crash.

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a bunch of black and white newspaper front pages are layered on top of each other with words like panic and crash and wall street
This is how papers across the country headlined the stock market plunge on Black Monday, Oct. 19, 1987.
AP Photo

HFT: Program trading on steroids

Fast forward 15 years, to 2002, when the New York Stock Exchange introduced a fully automated trading system. As a result, program traders gave way to more sophisticated automations with much more advanced technology: High-frequency trading.

HFT uses computer programs to analyze market data and execute trades at extremely high speeds. Unlike program traders that bought and sold baskets of securities over time to take advantage of an arbitrage opportunity – a difference in price of similar securities that can be exploited for profit – high-frequency traders use powerful computers and high-speed networks to analyze market data and execute trades at lightning-fast speeds. High-frequency traders can conduct trades in approximately one 64-millionth of a second, with the several seconds it took traders in the 1980s.

These trades are typically very short term in nature and may involve buying and selling the same security multiple times in a matter of nanoseconds. AI algorithms analyze large amounts of data in real time and identify patterns and trends that are not immediately apparent to human traders. This helps traders make better decisions and execute trades at a faster pace than would be possible manually.

Another important application of AI in HFT is natural language processing, which involves analyzing and interpreting human language data such as articles and social posts. By analyzing this data, traders can gain valuable insights into market sentiment and adjust their trading strategies accordingly.

Benefits of AI trading

These AI-based, high-frequency traders operate very differently than people do.

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The human brain is slow, inaccurate and forgetful. It is incapable of quick, high-precision, floating-point arithmetic needed for analyzing huge volumes of data for identifying trade . Computers are millions of times faster, with essentially infallible memory, perfect attention and limitless capability for analyzing large volumes of data in split milliseconds.

And, so, just like most technologies, HFT provides several benefits to stock markets.

These traders typically buy and sell assets at prices very close to the market price, which means they don't charge investors high fees. This helps ensure that there are always buyers and sellers in the market, which in turn helps to stabilize prices and reduce the potential for sudden price swings.

High-frequency trading can also to reduce the impact of market inefficiencies by quickly identifying and exploiting mispricing in the market. For example, HFT algorithms can detect when a particular stock is undervalued or overvalued and execute trades to take advantage of these discrepancies. By doing so, this kind of trading can help to correct market inefficiencies and ensure that assets are priced more accurately.

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a crowd of people move around a large room with big screens all over the place
Stock exchanges used to be packed with traders buying and selling securities, as in this scene from 1983. Today's trading floors are increasingly empty as AI-powered computers handle more and more of the work.
AP Photo/Richard Drew

The downsides

But speed and efficiency can also cause harm.

HFT algorithms can react so quickly to news and other market signals that they can cause sudden spikes or drops in asset prices.

Additionally, HFT financial firms are able to use their speed and technology to gain an unfair advantage over other traders, further distorting market signals. The volatility created by these extremely sophisticated AI-powered trading beasts led to the so-called flash crash in May 2010, when stocks plunged and then recovered in a matter of minutes – erasing and then restoring about $1 trillion in market value.

Since then, volatile markets have become the new normal. In 2016 research, two co-authors and I found that volatility – a measure of how rapidly and unpredictably prices move up and down – increased significantly after the introduction of HFT.

The speed and efficiency with which high-frequency traders analyze the data mean that even a small change in market conditions can trigger a large number of trades, leading to sudden price swings and increased volatility.

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In addition, research I published with several other colleagues in 2021 shows that most high-frequency traders use similar algorithms, which increases the risk of market failure. That's because as the number of these traders increases in the marketplace, the similarity in these algorithms can lead to similar trading decisions.

This means that all of the high-frequency traders might trade on the same side of the market if their algorithms release similar trading signals. That is, they all might try to sell in case of negative news or buy in case of positive news. If there is no one to take the other side of the trade, markets can fail.

Enter ChatGPT

That brings us to a new world of ChatGPT-powered trading algorithms and similar programs. They could take the problem of too many traders on the same side of a deal and make it even worse.

In general, humans, left to their own devices, will tend to make a diverse range of decisions. But if everyone's deriving their decisions from a similar artificial intelligence, this can limit the diversity of opinion.

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Consider an extreme, nonfinancial situation in which everyone depends on ChatGPT to decide on the best computer to buy. Consumers are already very prone to herding behavior, in which they tend to buy the same products and models. For example, reviews on Yelp, Amazon and so on motivate consumers to pick among a few top choices.

Since decisions made by the generative AI-powered chatbot are based on past training data, there would be a similarity in the decisions suggested by the chatbot. It is highly likely that ChatGPT would suggest the same brand and model to everyone. This might take herding to a whole new level and could lead to shortages in certain products and service as well as severe price spikes.

This becomes more problematic when the AI making the decisions is informed by biased and incorrect information. AI algorithms can reinforce existing biases when systems are trained on biased, old or limited data sets. And ChatGPT and similar tools have been criticized for making factual errors.

In addition, since market crashes are relatively rare, there isn't much data on them. Since generative AIs depend on data training to learn, their lack of knowledge about them could make them more likely to happen.

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For now, at least, it seems most won't be allowing their employees to take advantage of ChatGPT and similar tools. Citigroup, Bank of America, Goldman Sachs and several other lenders have already banned their use on trading-room floors, citing privacy concerns.

But I strongly believe banks will eventually embrace generative AI, once they resolve concerns they have with it. The potential gains are too significant to pass up – and there's a risk of being left behind by rivals.

But the risks to financial markets, the global and everyone are also great, so I hope they tread carefully.The Conversation

Pawan Jain, Assistant Professor of Finance, West Virginia University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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Black holes are mysterious, yet also deceptively simple − a new space mission may help physicists answer hairy questions about these astronomical objects

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theconversation.com – Gaurav Khanna, Professor of Physics, of Rhode Island – 2024-05-15 07:16:18

An illustration of a supermassive black hole.

NASA/JPL

Gaurav Khanna, University of Rhode Island

Physicists consider black holes one of the most mysterious objects that exist. Ironically, they're also considered one of the simplest. For years, physicists like me have been looking to prove that black holes are more complex than they seem. And a newly approved European space mission called LISA will us with this hunt.

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Research from the 1970s suggests that you can comprehensively describe a black hole using only three physical attributes – their mass, charge and spin. All the other properties of these massive dying , like their detailed composition, density and temperature profiles, disappear as they transform into a black hole. That is how simple they are.

The idea that black holes have only three attributes is called the “no-hair” theorem, implying that they don't have any “hairy” details that make them complicated.

Black holes are massive, mysterious astronomical objects.

Hairy black holes?

For decades, researchers in the astrophysics community have exploited loopholes or work-arounds within the no-hair theorem's assumptions to up with potential hairy black hole scenarios. A hairy black hole has a physical property that scientists can measure – in principle – that's beyond its mass, charge or spin. This property has to be a permanent part of its structure.

About a decade ago, Stefanos Aretakis, a physicist currently at the University of Toronto, showed mathematically that a black hole containing the maximum charge it could hold – called an extremal charged black hole – would develop “hair” at its horizon. A black hole's horizon is the boundary where anything that crosses it, even light, can't escape.

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Aretakis' analysis was more of a thought experiment using a highly simplified physical scenario, so it's not something scientists expect to observe astrophysically. But supercharged black holes might not be the only kind that could have hair.

Since astrophysical objects such as stars and planets are known to spin, scientists expect that black holes would spin as well, based on how they form. Astronomical evidence has shown that black holes do have spin, though researchers don't know what the typical spin value is for an astrophysical black hole.

Using computer simulations, my team has recently discovered similar types of hair in black holes that are spinning at the maximum rate. This hair has to do with the rate of change, or the gradient, of -time's curvature at the horizon. We also discovered that a black hole wouldn't actually have to be maximally spinning to have hair, which is significant because these maximally spinning black holes probably don't form in nature.

Detecting and measuring hair

My team wanted to develop a way to potentially measure this hair – a new fixed property that might characterize a black hole beyond its mass, spin and charge. We started looking into how such a new property might a signature on a gravitational wave emitted from a fast-spinning black hole.

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A gravitational wave is a tiny disturbance in space-time typically caused by violent astrophysical in the universe. The collisions of compact astrophysical objects such as black holes and neutron stars emit strong gravitational waves. An international network of gravitational observatories, the Laser Interferometer Gravitational-wave Observatory in the United States, routinely detects these waves.

Our recent studies suggest that one can measure these hairy attributes from gravitational wave data for fast-spinning black holes. Looking at the gravitational wave data offers an for a signature of sorts that could indicate whether the black hole has this type of hair.

Our ongoing studies and recent progress made by Som Bishoyi, a student on the team, are based on a blend of theoretical and computational models of fast-spinning black holes. Our findings have not been tested in the field yet or observed in real black holes out in space. But we hope that will soon change.

LISA gets a go-ahead

In January 2024, the European Space Agency formally adopted the space-based Laser Interferometer Space Antenna, or LISA, mission. LISA will look for gravitational waves, and the data from the mission could help my team with our hairy black hole questions.

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Three spacecrafts spaced apart sending light beams towards each other while orbiting the Sun

The LISA spacecrafts observing gravitational waves from a distant source while orbiting the Sun.

Simon Barke/Univ. Florida, CC BY

Formal adoption means that the has the go-ahead to move to the construction phase, with a planned 2035 launch. LISA consists of three spacecrafts configured in a perfect equilateral triangle that will trail behind the Earth around the Sun. The spacecrafts will each be 1.6 million miles (2.5 million kilometers) apart, and they will exchange laser beams to measure the distance between each other down to about a billionth of an inch.

LISA will detect gravitational waves from supermassive black holes that are millions or even billions of times more massive than our Sun. It will build a map of the space-time around rotating black holes, which will help physicists understand how gravity works in the close vicinity of black holes to an unprecedented level of accuracy. Physicists hope that LISA will also be able to measure any hairy attributes that black holes might have.

With LIGO making new observations every day and LISA to offer a glimpse into the space-time around black holes, now is one of the most exciting times to be a black hole physicist.The Conversation

Gaurav Khanna, Professor of Physics, University of Rhode Island

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Viruses are doing mysterious things everywhere – AI can help researchers understand what they’re up to in the oceans and in your gut

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theconversation.com – Libusha , Associate Professor of and Computational Biology, Microbiology and Immunology, Albert Einstein College of Medicine – 2024-05-15 07:16:41

Many viral genetic sequences code for proteins that researchers haven't seen before.

KTSDesign/Science Photo Library via Getty Images

Libusha Kelly, Albert Einstein College of Medicine

Viruses are a mysterious and poorly understood force in microbial ecosystems. Researchers know they can infect, kill and manipulate human and bacterial cells in nearly every environment, from the oceans to your gut. But scientists don't yet have a full picture of how viruses affect their surrounding environments in large part because of their extraordinary diversity and ability to rapidly evolve.

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Communities of microbes are difficult to study in a laboratory setting. Many microbes are challenging to cultivate, and their natural environment has many more features influencing their or failure than scientists can replicate in a lab.

So systems biologists like me often sequence all the DNA present in a sample – for example, a fecal sample from a patient – separate out the viral DNA sequences, then annotate the sections of the viral genome that code for proteins. These notes on the location, structure and other features of genes researchers understand the functions viruses might carry out in the environment and help identify different kinds of viruses. Researchers annotate viruses by matching viral sequences in a sample to previously annotated sequences available in public databases of viral genetic sequences.

However, scientists are identifying viral sequences in DNA collected from the environment at a rate that far outpaces our ability to annotate those genes. This means researchers are publishing findings about viruses in microbial ecosystems using unacceptably small fractions of available data.

To improve researchers' ability to study viruses around the globe, my team and I have developed a novel approach to annotate viral sequences using artificial intelligence. Through protein language models akin to large language models like ChatGPT but specific to proteins, we were able to classify previously unseen viral sequences. This the door for researchers to not only learn more about viruses, but also to address biological questions that are difficult to answer with current techniques.

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Annotating viruses with AI

Large language models use relationships between words in large datasets of text to potential answers to questions they are not explicitly “taught” the answer to. When you ask a chatbot “What is the capital of France?” for example, the model is not looking up the answer in a table of capital . Rather, it is using its on huge datasets of documents and information to infer the answer: “The capital of France is Paris.”

Similarly, protein language models are AI algorithms that are trained to recognize relationships between billions of protein sequences from environments around the world. Through this training, they may be able to infer something about the essence of viral proteins and their functions.

We wondered whether protein language models could answer this question: “Given all annotated viral genetic sequences, what is this new sequence's function?”

In our proof of concept, we trained neural networks on previously annotated viral protein sequences in pre-trained protein language models and then used them to predict the annotation of new viral protein sequences. Our approach allows us to probe what the model is “seeing” in a particular viral sequence that to a particular annotation. This helps identify candidate proteins of interest either based on their specific functions or how their genome is arranged, winnowing down the search of vast datasets.

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Microscopy image of spherical bacteria colored bright green

Prochlorococcus is one of the many species of marine bacteria with proteins that researchers haven't seen before.

Anne Thompson/Chisholm Lab, MIT via Flickr

By identifying more distantly related viral gene functions, protein language models can complement current methods to provide new insights into microbiology. For example, my team and I were able to use our model to discover a previously unrecognized integrase – a type of protein that can move genetic information in and out of cells – in the globally abundant marine picocyanobacteria Prochlorococcus and Synechococcus. Notably, this integrase may be able to move genes in and out of these populations of bacteria in the oceans and enable these microbes to better adapt to changing environments.

Our language model also identified a novel viral capsid protein that is widespread in the global oceans. We produced the first picture of how its genes are arranged, showing it can contain different sets of genes that we believe indicates this virus serves different functions in its environment.

These preliminary findings represent only two of thousands of annotations our approach has provided.

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Analyzing the unknown

Most of the hundreds of thousands of newly discovered viruses remain unclassified. Many viral genetic sequences match protein families with no known function or have never been seen before. Our work shows that similar protein language models could help study the threat and promise of our planet's many uncharacterized viruses.

While our study focused on viruses in the global oceans, improved annotation of viral proteins is critical for better understanding the role viruses play in health and disease in the human body. We and other researchers have hypothesized that viral activity in the human gut microbiome might be altered when you're sick. This means that viruses may help identify stress in microbial communities.

However, our approach is also limited because it requires high-quality annotations. Researchers are developing newer protein language models that incorporate other “tasks” as part of their training, particularly predicting protein structures to detect similar proteins, to make them more powerful.

Making all AI tools available via FAIR Data Principles – data that is findable, accessible, interoperable and reusable – can help researchers at large realize the potential of these new ways of annotating protein sequences leading to discoveries that benefit human health.The Conversation

Libusha Kelly, Associate Professor of Systems and Computational Biology, Microbiology and Immunology, Albert Einstein College of Medicine

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Human differences in judgment lead to problems for AI

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theconversation.com – Mayank Kejriwal, Research Assistant Professor of Industrial & Engineering, of Southern California – 2024-05-14 07:14:06

Bias isn't the only human imperfection turning up in AI.

Emrah Turudu/Photodisc via Getty Images

Mayank Kejriwal, University of Southern California

Many people understand the concept of bias at some intuitive level. In society, and in artificial intelligence systems, racial and gender biases are well documented.

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If society could somehow bias, would all problems go away? The late Nobel laureate Daniel Kahneman, who was a key figure in the field of behavioral economics, argued in his last book that bias is just one side of the coin. Errors in judgments can be attributed to two sources: bias and noise.

Bias and noise both play important roles in fields such as law, medicine and financial forecasting, where human judgments are central. In our work as computer and information scientists, my colleagues and I have found that noise also plays a role in AI.

Statistical noise

Noise in this context means variation in how people make judgments of the same problem or situation. The problem of noise is more pervasive than initially meets the eye. A seminal work, dating back all the way to the Great Depression, has found that different judges gave different sentences for similar cases.

Worryingly, sentencing in court cases can depend on things such as the temperature and whether the local football team won. Such factors, at least in part, contribute to the perception that the justice system is not just biased but also arbitrary at times.

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Other examples: Insurance adjusters might give different estimates for similar claims, reflecting noise in their judgments. Noise is likely present in all manner of contests, ranging from wine tastings to local beauty pageants to college admissions.

Behavioral economist Daniel Kahneman explains the concept of noise in human judgment.

Noise in the data

On the surface, it doesn't seem likely that noise could affect the performance of AI systems. After all, machines aren't affected by weather or football teams, so why would they make judgments that vary with circumstance? On the other hand, researchers know that bias affects AI, because it is reflected in the data that the AI is trained on.

For the new spate of AI models like ChatGPT, the gold standard is human performance on general intelligence problems such as common sense. ChatGPT and its peers are measured against human-labeled commonsense datasets.

Put simply, researchers and developers can ask the machine a commonsense question and compare it with human answers: “If I place a heavy rock on a paper table, will it collapse? Yes or No.” If there is high agreement between the two – in the best case, perfect agreement – the machine is approaching human-level common sense, according to the test.

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So where would noise in? The commonsense question above seems simple, and most humans would likely agree on its answer, but there are many questions where there is more disagreement or uncertainty: “Is the sentence plausible or implausible? My dog plays volleyball.” In other words, there is potential for noise. It is not surprising that interesting commonsense questions would have some noise.

But the issue is that most AI tests don't account for this noise in experiments. Intuitively, questions generating human answers that tend to agree with one another should be weighted higher than if the answers diverge – in other words, where there is noise. Researchers still don't know whether or how to weigh AI's answers in that situation, but a first step is acknowledging that the problem exists.

Tracking down noise in the machine

Theory aside, the question still remains whether all of the above is hypothetical or if in real tests of common sense there is noise. The best way to prove or disprove the presence of noise is to take an existing test, remove the answers and get multiple people to independently label them, meaning answers. By measuring disagreement among humans, researchers can know just how much noise is in the test.

The details behind measuring this disagreement are complex, involving significant statistics and math. Besides, who is to say how common sense should be defined? How do you know the human judges are motivated enough to think through the question? These issues lie at the intersection of good experimental design and statistics. Robustness is key: One result, test or set of human labelers is unlikely to convince anyone. As a pragmatic matter, human labor is expensive. Perhaps for this reason, there haven't been any studies of possible noise in AI tests.

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To address this gap, my colleagues and I designed such a study and published our findings in Nature Scientific Reports, showing that even in the domain of common sense, noise is inevitable. Because the setting in which judgments are elicited can matter, we did two kinds of studies. One type of study involved paid workers from Amazon Mechanical Turk, while the other study involved a smaller-scale labeling exercise in two labs at the University of Southern California and the Rensselaer Polytechnic Institute.

You can think of the former as a more realistic online setting, mirroring how many AI tests are actually labeled before being released for and evaluation. The latter is more of an extreme, guaranteeing high quality but at much smaller scales. The question we set out to answer was how inevitable is noise, and is it just a matter of quality control?

The results were sobering. In both settings, even on commonsense questions that might have been expected to elicit high – even universal – agreement, we found a nontrivial degree of noise. The noise was high enough that we inferred that between 4% and 10% of a system's performance could be attributed to noise.

To emphasize what this means, suppose I built an AI system that achieved 85% on a test, and you built an AI system that achieved 91%. Your system would seem to be a lot better than mine. But if there is noise in the human labels that were used to score the answers, then we're not sure anymore that the 6% improvement means much. For all we know, there may be no real improvement.

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On AI leaderboards, where large language models like the one that powers ChatGPT are , performance differences between rival systems are far narrower, typically less than 1%. As we show in the paper, ordinary statistics do not really come to the rescue for disentangling the effects of noise from those of true performance improvements.

Noise audits

What is the way forward? Returning to Kahneman's book, he proposed the concept of a “noise audit” for quantifying and ultimately mitigating noise as much as possible. At the very least, AI researchers need to estimate what influence noise might be .

Auditing AI systems for bias is somewhat commonplace, so we believe that the concept of a noise audit should naturally follow. We hope that this study, as well as others like it, to their adoption.The Conversation

Mayank Kejriwal, Research Assistant Professor of Industrial & Systems Engineering, University of Southern California

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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