Lately, we've been exploring the exciting segment of the market known as fintech - short for financial technology.
It's changing the way we live, bit by bit, tearing down the old paper-and-pencil processes behind global finance and building a high-tech infrastructure in its place.
And when I say that fintech will change everything, I'm not exaggerating - it's not just about mobile banking and Bitcoin and blockchain technology...
The next big thing in fintech is going to change the markets forever. It's going to change how you invest, why you invest, and who you trust to manage your money.
I'm talking about artificial intelligence.
Here's what AI trading is all about, who's doing what, and how it's about to upend every bank's "value-at-risk" (VaR) modeling, which nearly destroyed the financial world in 2008.
Let's get to it...
The Future of Rich
AI trading isn't computer-driven high frequency trading (HFT) or front-running everyone's orders. It isn't trading based on quantitative mathematical models. It isn't static strings of algorithmic if-this then-that models.
Artificial intelligence trading is about machines learning what and how to trade.
AI trading is about replacing what isn't working anymore - because the world's changed, because technology's changed everything, because what used to work, especially for super-profitable hedge funds, isn't working any more.
It's about deep learning, evolutionary computation, and algorithms learning from themselves.
Deep learning is where large virtual neural networks train themselves to recognize patterns. Where news, social media inputs, consumer ordering and buying data, and company metrics convened in real-time are woven together to reveal actual and developing patterns and probability outcomes.
It's about building machines that learn from the constant flow of data streaming through them, finding trades defined by risk and reward probabilities, signaling entry and exit points, and moving stops and profit targets based on changing market conditions.
In short, every decision that you make regarding a trade - when to buy, when to sell, when to load up on shares of an existing position, where to set your stops, when to adjust them, and by how much, and hundreds of other decisions - can now be made in real time by a machine.
And the more the machine trades, the smarter - and more profitable - it becomes.
Sound like science fiction?
It's not as far-fetched as you might think. In fact, it's already happening...
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Who's Who in AI Trading Right Now
AI trading isn't new. Academics, roboticists, mathematicians, rocket scientists, and bankers have been building AI machines for years.
The precursors to AI are computer-driven models, themselves increasingly being employed on trading desks, at hedge funds, and by individual investors employing over-the-counter and customized clear-view and blackbox programs.
According to Preqin, a hedge fund data company, 1,360 hedge funds managing $197 billion today use computer programs to drive the majority of their trades.
In 2015, 40% of new hedge funds were "systematic" (computer model-driven) trading funds, as opposed to "discretionary" trading funds where fundamental, technical, and quantitative analytics determine what trades portfolio managers put on, says Preqin.
Singapore-based hedge fund data provider Eurekahedge, with over 25,000 hedge fund managers in their database, reported recently that hedge funds using AI outperformed the averages and most other funds over the past seven years.
That's why a lot of funds, banks, and institutional asset managers are increasingly delving into AI.
Two of the biggest, most secretive, and most successful hedge funds in the world, Renaissance Technologies and D.E.Shaw have been employing AI for years.
Both firms were founded by math geniuses and employ scientists with multiple disciplines to build cutting-edge, self-learning, big-databased trading systems. It's been rumored that ultra-secretive Renaissance Technologies employs more Ph.Ds than MIT.
The largest hedge fund complex in the world, Bridgewater Associates, run by investing guru Ray Dalio, is delving deeply into AI trading technology. So is Point72 Asset Management, the "family office" running some $10 billion of hedge fund maven Steven A. Cohen's money.
New shops like Two Sigma, Rebellion Research, and Sentient Technologies have been gathering investor money and trading off AI machines.
San Francisco-based Sentient Technologies, run by CEO Antoine Blondeau, garnered $143 million in funding and began trading last year.
According to Sentient's chief science officer, Babak Hodjat, who was on the team that built digital assistant Siri, later bought by Apple, says the fund's system "automatically authors a strategy and gives it commands." Without any human intervention, Hodjat says, "It says: Buy this much now, with this instrument, using this particular order type, and also tells us when to exit, reduce exposure, and that kind of stuff."
Of the existing funds employing AI for years, Mohammed Hassan, a noted analyst at Eurekahedge says, "There are some very disciplined AI programs with strong emphasis on downside protection that have been around for more than five years and have delivered double-digit returns, and then there are others with really volatile returns that the average hedge fund investor would shy away from."
The truth about AI trading is that it's not perfect, and there's no way it ever will be.
That's because if ultimately artificial intelligence machines can gather inordinate amounts of data and see patterns in them that lead to good trades, others will find a ways to replicate those machines, and come up with lots of the same trades.
In other words, if everyone's using AI technology, their predictions, via their trading orders, will get priced in and profit opportunities will be squeezed out.
Of course, there will be huge winners whose AI technology will be first to market, better than everyone else's, and there'll be lots of unique learning systems capable of generating huge returns.
I'll be watching all of them and let you know what they're doing and how they're doing... and, of course, how you can profit.
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This Fintech Experiment Could Be Huge... Would you invest in a company with no managers or legal documents, but with an entirely new decentralized method of trading? That's what this experimental firm - which just raised over $152 million via crowdfunding - is attempting - but it may not even be legal...
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.