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AI trading: How does it work and risks

Updated: Apr 30


The author Satu Kauppinen of the article:" AI trading: How does it work and risks"

Publication date: 23.10.2023





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How will artificial intelligence impact trade patterns, and how does it reshape our perspectives on trade policy? More and more investment firms are adopting AI. Specifically machine learning methods within the ramification of algorithmic trading have gained more interest.


What means AI trading

AI trading can be also called algorithmic trading or automated trading. It is a method which uses computer algorithms to execute financial transactions. Algorithms are designed to analyse market data, make trading choices, and execute orders without human involvement. In fact, AI trading systems use various techniques from artificial intelligence and machine learning. With those techniques AI trading systems identify patterns, trends, and opportunities in financial markets.


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How does AI trading work

AI trading systems rely heavily on the analysis of vast amounts of historical and real-time market data. In particular, it includes price movements, trading volumes, news sentiment, and other relevant factors.

Traders and data scientists create algorithms that are capable of making trading decisions based on the analyzed data. These algorithms can be simple rules-based strategies or highly complex machine learning models.


AI trading: algorithmic trading or automated trading

Risk management

Effective AI trading systems incorporate risk management strategies to control the amount of capital at risk in each trade. This includes setting stop-loss orders and defining position sizing rules.

Some AI trading systems are specifically created for high-frequency trading. Their orders are executed in a matter of microseconds to take advantage of very short-term price movements.


Machine learning techniques

Machine learning techniques are often used to build predictive models. These can forecast future price movements or identify trading opportunities. Before deploying an AI trading strategy in a live market, it is typically back-tested using historical data. As a result, that helps to evaluate strategies performance and refine parameters.


Automated trading and order execution

Once a trading signal is generated by the AI system, it automatically executes buy or sell orders in the market. These orders can be placed on various financial instruments, including stocks, currencies, commodities, and cryptocurrencies. What’s more, AI trading systems need fast and reliable connections to exchanges and trading platforms to ensure the timely execution of orders.


Regulatory compliance and monitoring

As regulatory requirements and market dynamics evolve, AI trading systems must undergo continuous monitoring and periodic updates to ensure adherence to regulatory standards and maintain peak performance.


Risks of AI trading

The application of AI in trading, while offering potential advantages, also comes with inherent risks. Market fluctuations and unanticipated occurrences can lead to losses, necessitating a thorough understanding of AI principles, financial market dynamics, and risk management techniques for responsible and successful implementation.


EU Laws

Existing legal frameworks and enforcement mechanisms may not be sufficient to address the complexities of AI-driven trading activities, increasing the risk of algorithmic market manipulation.


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