Despite the constant improvements and developments in AI technology, the term “artificial intelligence” actually dates back to 1956. This term was coined by John McCarth a Stanford researcher who explained AI as:
“The ability of a machine or a computer program to think and learn. The concept of AI is based on the idea of building machines capable of thinking, acting, and learning like humans”
Today, Artificial Intelligence is being used in numerous well-known applications such as Apple’s Siri, Google Search, Gmail and Google Maps. Bottom line is, Artificial intelligence is here, is popular, and is successful.
As traders why wouldn’t we take advantage of its abilities? As McCarth himself said, an AI-driven computer by definition is trained to think, act, and learn just as well if not better than humans. This article will outline the significant benefit of using AI- powered Backtesters in your trading.
Artificial Intelligence for trading
As traders, we have a constant flow of information coming our way. Our goal is to filter the signal out of the noise. With information increasing both in speed and in size every day, we need to recognize which information actually affects the markets and which direction it is going to affect. It is crucial that we are able to understand what types of information are just influencing and causing a market reaction versus which types of information have the potential to harm us by increasing the volatility very quickly.
Here, Artificial Intelligence can be a real help in order to see how this information affects the markets in real time. This is usually done by using the backtesting technology.
Significance of the Backtester:
Before we get into how AI can benefit traders, let’s examine the significance of Backtesting and thereby the importance of having and accurate and well rounded Backtester.
Backtesting needs to be an integral step of any strategy. Skipping this aspect of trading is ensured to cost money as it will lower your success in profits. If created and interpreted properly, it can help traders optimize and improve their strategies, find any technical or theoretical flaws, as well as gain confidence in their strategy before applying it to the real world markets. The basic idea of backtesting is creating trades through historical data that would have been successful trades in the past using rules of your specific strategy. The theory is that any strategy that worked well in the past is going to work well in the future. Conversely, any strategy that performed poorly in the past is likely to perform poorly in the future.
Benefits of AI:
Artificial Intelligence is extremely beneficial when it comes to backtesting well and efficiently. Unlike humans, AI doesn’t need to sleep, rest, take breaks, or get bored. Therefore, AI can constantly be running, testing new and different circumstances for you, to make sure you are getting the most accurate and well-proven situations to compare to your current situation.
Additionally, unlike even the most experienced traders who sometimes make mistakes, especially when dealing with repetitive tasks, when coded properly, AI has an exceptionally low error rate even when going through repetitive tasks. AI has incredible precision, accuracy, and speed which is also very important when backtesting as it can run through multiple historical situations accurately at an inhumane speed. It has the ability to spot anomalies in a matter of seconds and apply those to any situation throughout history.
Lastly, it is clear that in trading there can be no emotion based responses. AI thinks logically and without emotions. Therefore, it can make rational decisions that have no mistakes. When these characteristics get applied to backtesting you are guaranteed for success.
When Human Ability Overcomes the AI:
While AI has amazing abilities, humans have a skill that is unteachable to computers. Humans understand context. Therefore, humans understand that despite something happening in the past it may not be the same situation today based on the context surrounding the situation. For example, if in the past there has been a pattern that the markets go up every Sunday, but this Sunday President Trump tweeted about the possibility of attacking Iran, a human can get the context, and understand that the
S&P 500 is going to go down and they should not trade. A computer could not possibly know this as Trump has never tweeted that before and would advise you to follow the market pattern of “Mondays the market goes up.” This is why you need to choose to use both AI to help get great real-time analysis and also the context to react when it makes sense to based off of common sense, context and AI. As Paul Tudor Jones says;
“No man is better than a machine, and no machine is better than a man with a machine.”
In conclusion, this article has reviewed the basic theory of the backtester and has shown the added benefit of using AI- powered algorithms in your backtester. Through utilizing AI in your backtester you are guaranteed to have more profitable trades and more accurate strategies, as AI has the advantage of speed, rational and perfection.