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Advances in AI could lead to undesirable results for investors in the future.
As AI advances accelerate markets and also create more complex trading models, many stocks may become overcrowded in the search for alpha and risk rapid downdrafts if information changes, warns the CEO of Tradeweb Markets ( TW), Billy Hult.
“It's something [we have] think carefully,” Hult told Yahoo Finance executive editor Brian Sozzi on his Opening Offer podcast (video above; listen on here).
Crowded trades occur when similar investment strategies, usually driven by complex trading models, cause all investors to opt for the same stocks. Shares of overcrowded stocks tend to rise as bulls rush in with reckless abandon and little attention is paid to a company's valuation.
Liquidity shortages, volatility spikes, and short squeezes are some of the risks that come with crowded trading.
The other risk is that the stock could be significantly affected if information changes, sending everyone out at once.
The latest example: the rapid sell-off in the markets at the beginning of August.
Bank of America strategists said in a report at the time that “crowding risk mattered” and saw “less crowded stocks outperforming more crowded ones by eight percentage points.”
Magnificent 7 tech stocks gained popularity again this summer, as AI chip powerhouse Nvidia (NVDA) enjoyed a brief stay as the world's most valuable public company.
Professionals like Hult argue that this kind of accumulation of high-performing stocks will only get worse as AI makes markets more sophisticated.
However, AI advocates envision a world where traders are better informed through deeper insights gleaned from a variety of sources.
“I think we are going to continue to see data-driven execution in fixed income trading. And we're going to continue to see how machine learning is applied, sort of like the search for liquidity in fixed income,” Hult said. “The next level of technology will be more sophisticated.”
Hult is a long-time evangelist for the integration of finance, investment vehicles and disruptive technology. As an electronic marketplace builder, Tradeweb has worked with companies looking to unite investors and machines. But it also stays true to the need for more interpersonal soft skills.
“[Tradeweb] has lived and breathed the spirit of the market for a long time,” Hult said. “We really value the personal relationships side of the business.”
Three times a week, Yahoo Finance executive editor Brian Sozzi offers knowledge-filled conversations and chats with the biggest names in business and markets in opening offer. You can find more episodes in our video center or look in your preferred streaming service.
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