The lessons of this May's 1,000-point Dow Jones drop due to errors in high-speed automated trading were not lost on Wall Street, which has decided that more robots are the key to financial stability. But not just more robots. Faster, smarter, increasingly self-reliant robots that can learn from their mistakes (just like Wall Street does!) as they manage an ever-rising share of the day-to-day trading of financial products.
The artificial intelligence process known as "machine learning" is already used by Google to match search results and by NetFlix to recommend movies, so clearly it will soon be ready to handle the $12.25 trillion in assets listed on the New York Stock Exchange. The Wall Street Journal's Scott Patterson reports "an increasing number of investors who are turning to the science of artificial intelligence to make investment decisions."
One upstart in the AI race on Wall Street is Rebellion Research, a tiny New York hedge fund with about $7 million in capital that has been using a machine-learning program it developed to invest in stocks. Run by a small team of twentysomething math and computer whizzes, Rebellion has a solid track record, topping the Standard & Poor's 500-stock index by an average of 10% a year, after fees, since its 2007 launch through June, according to people familiar with the fund. Like many hedge funds, its goal is to beat the broader market year after year.
... Rebellion is part of a new wave of firms using machine learning to trade. Cerebellum Capital, a San Francisco hedge fund with $10 million in assets, started using machine learning to invest in 2009. A number of high-frequency trading firms, such as RGM Advisors LLC in Austin, Texas, and Getco LLC in Chicago, are using machine learning to help their computer systems trade in and out of stocks efficiently, according to people familiar with the firms.
What could possibly go wrong?
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