Will AI and mobile usher in a more perfect market?

Published: December 23, 2016

Ravi Koka, Founder, Stocksnips Inc 12/23/2016

Role of technology in the evolution of the stock market

Technology has played a crucial role in the development of the stock market over the last 5 decades. The exchanges we see today with instant access to stock prices, trading volumes, bids and asks was not always the case. In England brokers and investors did business in coffee houses in the eighteenth century. In 1971 when NASDAQ introduced a computer network that provided real time quotes for OTC stocks it significantly improved the investors’ ability to trade on accurate bid and ask prices. In the 1900’s there were several abuses as OTC stocks did not have this facility and brokers and speculators abused the system. Even at NYSE the major exchange in the United states in the 1920’s trades took place through specialists who matched the bid and ask prices for a company. The information flowing through the exchange was monopolized by NYSE and investors across the country had to depend on the ticker on the trading floor to monitor share prices during the day. The 1900’s therefore was not a perfect market place for investors and eventually resulted in the collapse of the market in the 1930’s during the great depression. The securities and exchange commission and the NASD were set up to regulate the markets and to create a market where investors could be confident that their investments were protected from abuse. These agencies have strived to evolve standards on information that companies have to provide to brokers and investors.

Towards a perfect market

Eugene Fama proposed the efficient market hypothesis which states that security prices fully reflect all available information. However, this is not achievable even in the United states with the most advanced electronic trading system. Information dissemination is not always timely and accurate. It is open to bias and some of the intermediaries may have easier access to quality information than the average investor. To some extent the internet has leveled the playing field and information about stocks including company filings to the SEC regarding quarterly performance are available to everyone at the same time. 24 / 7 financial news channels like Bloomberg and CNBC provide the investor analysis and opinions of several experts that follow the markets closely. There is however an explosion of information and for the investor it is like drinking from a fire hose. Behavioral economists have observed that cognitive load and bias leads to human errors and delay in information processing.

Real time Stock news sentiment analysis

The advent of AI and machine learning technologies and their ability to provide expert analysis of news by sifting through large amounts of data in real time could lead to a more perfect market place as hypothesized by Fama. Several studies have shown that positive and negative news impacts stock prices. Tetlock et al in their paper in the Journal of Finance in 2008 studied the correlation between financial news and stock returns. Their findings suggest that stock news and analysis captures otherwise hard-to-quantify aspects of a company’s performance. This information is quickly incorporated into stock prices by investors. Mobile technology has made access to information even more ubiquitous and an investor can stay connected anywhere and anytime if he chooses to. It is now possible to deliver news sentiment for companies continuously. Investors could leverage this channel in addition to other media that they currently depend on.

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