Here’s How to Use AI to Pick Stocks and Whether or Not It is a Good Strategy

As Artificial Intelligence (AI) becomes more widespread, investors are asking how to use AI to pick stocks. We will cover how you can, but also whether or not you really should be using it.

There’s no one size fits all answer, it all depends on your risk tolerance, goals, and your understanding of the specific AI technology you will use and the limitations.

How to use AI to pick stocks

There are 3 ways to use AI to pick stocks. But just before we delve into them, we will note that we are talking generally – we will not recommend any specific trading platforms.

One way AI can be used to pick stocks is building Machine Learning Models. These can analyse historical data (such as share prices, technical analysis, market sentiment, company fundamentals and macroeconomic indicators) to identify patterns and predict future stock price movements.

The second way to use AI to pick stocks is using AI for sentiment and risk analysis. AI can process vast amounts of unstructured text data from sources like news articles, financial reports, and social media platforms to gauge market sentiment. Sentiment analysis helps determine whether the mood around a particular stock is positive, negative, or neutral, which can influence stock prices. Moreover, AI can assess risks in real-time by tracking a wide range of factors, including price volatility, correlations between stocks, and even geopolitical risks. It can adjust portfolio allocations dynamically to limit losses during volatile periods.

The third way is algorithmic trading. Some AI-driven platforms are designed to execute trades automatically based on predefined strategies. This could involve statistical arbitrage, market-making, or trend-following strategies. AI can trade at a faster pace and with greater precision than humans, capitalizing on small price movements and inefficiencies.

The fourth is Portfolio Optimisation. AI can help in creating an optimised portfolio by analysing risk-return profiles of different assets, helping you to balance your portfolio based on your specific investment objectives. Techniques like mean-variance optimization or newer methods such as deep learning can be applied to enhance diversification and minimise risk.

The Pros and Cons of using AI to Pick Stocks

Let’s take a look at the advantages and disadvantages of using AI to pick stocks.

The advantages include the Speed and Efficiency with which data can be handled and interpreted. AI can analyse massive datasets and make predictions much faster than a human could, uncovering opportunities that might not be obvious to human traders. Further, AI can process and interpret both structured (numerical data) and unstructured (text, sentiment) data, offering a more holistic view of the market, and removing the emotional biases that can affect human decision-making.

Now onto the limitations and risks. You would’ve heard the saying that past performance is not a reliable indicator of future performance. So it is the case here. AI models can sometimes become overfitted to past data, which means they perform well on historical data but may not generalise well to future or unseen data. Moreover, Many AI models, especially deep learning models, operate as “black boxes,” making it difficult to understand exactly how they are making decisions. This lack of transparency can be a concern for investors who want to know why certain decisions are made.

Notwithstanding our comments above about AI being able to help capture sentiment and perform risk analysis by capturing certain factors, others factors are more difficult (e.g., political events, human psychology). And finally, the rise of AI in trading means that these models may face diminishing returns over time as everyone starts using similar strategies.

So, Should You Use AI to Pick Stocks?

It depends. If you’re an experienced investor already familiar with the ins and outs of the market, AI tools can help you enhance your strategy by identifying hidden patterns and improving efficiency. It could be useful for high-frequency trading, swing trading, or market timing strategies.

For Long-Term Fundamental Investors, AI can be used to analyse long-term trends, optimise portfolios, and assist with risk management, making it an appealing tool for those looking to improve their returns while minimising risk.

But, AI may not be suitable in other circumstances. If you’re new to investing, relying on AI for stock picking without a solid understanding of the underlying principles of investing could be risky. AI strategies require constant monitoring and adjustment.

If you’re more comfortable with a “set it and forget it” approach (e.g., buying ASX ETFs and holding them long-term), AI might not add much value to your strategy. AI-driven stock-picking is often more suited to active investors.

Finally, we note that (subject to which AI solution you’re picking), if you prefer making investment decisions manually or enjoy the process of researching stocks yourself, relying on AI could feel like giving up control over your investments.

Conclusion: Should You Use AI for Stock Picking?

To make a long story short, whether or not you should use AI to pick stocks depends on your level of expertise, investment goals, and comfort with technology. AI can enhance your investment strategy, but it’s not a error-proof solution. If you’re new to investing or not comfortable with the complexities of AI, it might be better to stick with traditional approaches, such as index funds or a diversified portfolio.

However, if you’re an experienced investor looking to refine your strategy, AI can provide powerful insights and automation tools that can potentially give you an edge in the market. Just make sure to understand the tools you’re using, and consider combining AI insights with your own judgment and risk management principles.

What are the Best ASX Stocks to invest in right now?

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