Viet Anh Pham
Viet Anh Pham

Robo-Advisers - Welcome To The Future

Capital markets are increasingly dominated by artificial intelligence and the rise of robo-advisers. Viet Anh Pham provides an insight on the impacts of AI-driven trading solutions on the foreign exchange trading space.

The last decade has seen drastic technological changes, with trading being increasingly performed without human intervention. As artificial intelligence is beginning to spread across the foreign exchange and other fast-paced electronic markets, a growing number of traders rely on automated systems that fire off trades within milliseconds.

According to a report by the Bank for International Settlements, the oldest global financial institution, trading volumes in the forex market, one of the world’s most liquid, have almost doubled since 2008. The rise of AI trading bots, computer programmes that are able to recognise trends and automatically execute trades, has contributed considerably to that trend.

Trading bots with artificial intelligence

“Traditional” trading bots that are based on largely deterministic algorithms are already a standard tool in forex trading. AI, however, brings the common model of trading bots to a whole new level by allowing them to update their algorithm.

AI trading bots are fed with large amounts of data in order to not only predict changes in the market but to also react to them accordingly. The more scenarios they “experience,” the more sophisticated their solution strategies become. In other words, AI trading bots are able to improve their accuracy by “learning” from previous results.

Another example of how AI is implemented in forex trading are robo-advisers, digital platforms that provide automated, algorithm-driven financial services. Based on machine learning, backtesting and big data analysis, robo-advisers construct, manage and optimise investment portfolios in line with a client’s needs and risk tolerance. All this happens automatically and without human intervention. Figure 1 illustrates AI has changed the trading process.

The benefits of robo-advisers

Robo-advisers feature several characteristics that are of particular advantage in forex trading. The foreign exchange market can benefit from these AI-driven trading tools for a number of reasons.

Fast – Robo-advisers automatically invest capital by choosing from tens of thousands of tried and tested strategies in fractions of a second, crunching data faster and in much larger quantities than would ever be possible manually. The pace at which trades can be executed is undoubtedly one of the primary advantages of robo-advisers.

Figure 1: Conventional forex trading versus AI-based forex trading (Source: WinFX)
Figure 1: Conventional forex trading versus AI-based forex trading (Source: WinFX)

Simple – Everyone likes things to be easy, which is another reason for the growing popularity of robo-advisers. While it doesn’t have to be set and forget, they have made it easy to create an individual account, make recurring contributions, and build portfolios that match the traders’ goals. In most cases, all investors need to do is provide details on their age, preferred risk strategy and financial position.

Flexible – Forex trading is a 24/5 market. Alas, humans don’t have unlimited time on their hands. Apart from basic needs such as eating and sleeping, they also have other responsibilities, including family, work and friends. It is next to impossible for humans to trade the entire 24-hour currency market. Instead, trades are often executed at pre-defined time periods, meaning that traders are missing out on opportunities that arise outside of their usual office hours. Robo-advisers, however, can monitor hundreds of markets – all day, every day. Thus, investors don’t have to watch price movements 24 hours, five days a week to keep up to date with the latest developments.

Emotionless – Fear and greed are the biggest obstacles to successful trading. Fear of loss becomes an irrational force when it prevents traders from executing profitable trades or makes them hesitate too long. Greed, the emotional opposite, can cause traders to execute random trades or hold on to positions longer than is sensible. Humans are also constrained by ego and bias, making them unable to assess trading decisions critically and objectively. They are prone to selective perception and only see what they want to see, especially when money is at stake. Robo-advisers, however, eliminate the chance of making irrational trading decisions based on gut feelings. As with any automated trading tool, they follow a very strict and consecutive plan. This prevents investors from diving into a reckless trade or holding on to a losing trade for longer than they should.

AI trading bots are able to improve their accuracy by “learning” from previous results
AI trading bots are able to improve their accuracy by “learning” from previous results

Backtested – Before, human traders flinched from the mammoth task of combing through large amounts of data to detect patterns or underlying rules that were related to their indicators. Each change in their indicators’ parameters would inevitably lead to reruns, which made optimising processes rather challenging. Robo-advisers, on the other side, are able to quickly interpret huge numbers of data points and analyse how markets have behaved in the past. Unlike humans, they can recognise patterns and identify market trends within minutes.

Accessible – Newbies can get their feet wet with robo-advisers without having an in-depth knowledge of forex trading. With robo-advisers, they don’t need to start out being an expert trader or programmer. There are plenty of free and commercial robo-advisers, allowing them to dip their toes into the world of forex trading.

There are other factors that contributed considerably to the rise of robo-advisers in forex trading. The AI-driven automated trading tools also benefited from several preconditions that have finally been met.

Both the emergence of big data and the increasing computing power contributed considerably to the growing importance of AI. They paved the way for the creation of complex algorithms and risk management strategies. With computer performance and storage capacity growing exponentially, machines are now able to process huge amounts of data and implement them in automated trading systems.

Dawn of a new era

Robo-advisers are still in their infancy, but they represent the fastest growing area of wealth management globally. Stockspot, an online investment adviser, estimates that US$2.2 trillion, that is five percent of all money worldwide, will be managed by robo-advisers by 2020. In a separate study, the investment bank Goldman Sachs found that up to 43 billion US dollars annually can be saved by using AI in the trading sector.

Forex traders will have to ask themselves to what extent they want to use the added value of the analytical capabilities of AI to obtain new yield and correlation profiles. So far, AI has only contributed to making current trading processes even more efficient. But with the advance of machine learning and forecasting algorithms, the first steps have been taken to create new opportunities for an even more extended automation in the forex trading space.

With the rising importance of AI, specifically in the form of robo-advisers, the future of forex trading becomes increasingly emotionless.
With the rising importance of AI, specifically in the form of robo-advisers, the future of forex trading becomes increasingly emotionless.

With the rising importance of AI, specifically in the form of robo-advisers, the future of forex trading becomes increasingly emotionless. However, humans will still play a role in this new trading future – even though it will be one behind the scenes.

It is true that robo-advisers are far superior to their human counterparts when it comes to modelling potential outcomes, recognising trading patterns and tracking market trends. However, robo-advisers need to be well-coded, fully backtested and properly monitored as well – and that is where the human component comes into play. Humans will also be required when it comes to assessing the robo-advisers’ performance and checking if they are in line with investment goals. When confronted with profound changes – and the advance of robo-advisers in the forex trading space can surely be regarded as such – some people tend to bury their heads in the sand. That is one way of dealing with an upcoming revolution. It is also incredibly dull and unrewarding. From my experience, embracing change instead of ignoring or even trying to prevent it, is so much more promising. As an ancient Chinese proverb so aptly put it: “When the wind of change blows, some people build walls, others build windmills.”

Let’s go and build windmills, shall we?