Lessons from finance’s experience with artificial intelligence | The Economist

Yet automation’s great march forward has not continued unabated—humans have fought back. Towards the end of 2019 all the major retail brokers, including Charles Schwab, e*trade and td Ameritrade, slashed commissions to zero in the face of competition from a new entrant, Robinhood. A few months later, spurred by pandemic boredom and stimulus cheques, retail trading began to spike. It reached a peak in the frenzied early months of 2021 when day traders, co-ordinating on social media, piled into unloved stocks, causing their prices to spiral higher. At the same time, many quantitative strategies seemed to stall. Most quants underperformed the markets, as well as human hedge funds, in 2020 and early 2021. aqr closed a handful of funds after persistent outflows.

When markets reversed in 2022, many of these trends flipped. Retail’s share of trading fell back as losses piled up. The quants came back with a vengeance. aqr’s longest-running fund returned a whopping 44%, even as markets shed 20%.

This zigzag, and robots’ growing role, holds lessons for other industries. The first is that humans can react in unexpected ways to new technology. The falling cost of trade execution seemed to empower investing machines—until costs went to zero, at which point it fuelled a retail renaissance. Even if retail’s share of trading is not at its peak, it remains elevated compared with before 2019. Retail trades now make up a third of trading volumes in stocks (excluding marketmakers). Their dominance of stock options, a type of derivative bet on shares, is even greater.

The second is that not all technologies make markets more efficient. One of the explanations for aqr’s period of underperformance, argues Cliff Asness, the firm’s co-founder, is how extreme valuations became and how long a “bubble in everything” persisted. In part this might be the result of overexuberance among retail investors. “Getting information and getting it quickly does not mean processing it well,” reckons Mr Asness. “I tend to think things like social media make the market less, not more, efficient…People don’t hear counter-opinions, they hear their own, and in politics that can lead to some dangerous craziness and in markets that can lead to some really weird price action.”