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Advances in AI could trigger unwelcome outcomes for investors in the future.
As AI advances speed up markets and also create more complex trading models, a lot of stocks may become overcrowded in the search for alpha — and at risk for swift downdrafts if information changes, warns Tradeweb Markets (TW) CEO Billy Hult.
"It's something [we have] to think through," Hult told Yahoo Finance executive editor Brian Sozzi on his Opening Bid podcast (video above; listen in here).
Crowded trades occur when similar investment strategies — usually fueled by complex trading models —send investors all into the same stocks. Shares of the overcrowded stocks tend to rise as the bulls rush in with reckless abandon, and little attention is paid to a company's valuation.
Liquidity shortages, spikes in volatility, and short squeezes are some risks that come with crowded trades.
The other risk is that the stocks could get hammered significantly if information changes, sending everyone headed for the exit all at once.
The latest example: the swift sell-off in markets in early August.
Bank of America strategists said in a report at the time that “crowding risk mattered,” and it saw “the least crowded stocks outperforming the most crowded by eight percentage points.”
The Magnificent 7 tech stocks rose again in popularity this summer, as AI chips powerhouse Nvidia (NVDA) enjoyed a brief stay as the world's most valuable public company.
Pros like Hult argue this type of crowding into top-performing stocks will only worsen as AI makes markets more sophisticated.
Proponents of AI envision, however, a world where traders are better informed through deeper insight gathered from a variety of sources.
“I think we’re going to continue to see data driven execution in fixed income trading. And we're going to continue to see machine learning get applied to, sort of how the search for liquidity occurs in fixed income,” said Hult. “The next level of technology is going to be more sophisticated.”
Hult is a longtime evangelist of integrating finance, investment vehicles, and revolutionary technology. As a builder of electronic marketplaces, Tradeweb has worked with firms that seek to unite investors and machines. But it also stays true to the need for softer people skills.
“[Tradeweb] has lived and breathed in the ethos of the market for a long time,” Hult said. “We really value the personal relationship side of the business.”
Three times each week, Yahoo Finance Executive Editor Brian Sozzi fields insight-filled conversations and chats with the biggest names in business and markets on Opening Bid. You can find more episodes on ourvideo hub or watch on yourpreferred streaming service.
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