Trading on AI: The GameStop Phenomenon

Published
Feb 3, 2021
Reading time
2 min read
Trading on AI: The GameStop Phenomenon

Dear friends,

The price of shares in video game retailer GameStop (NYSE: GME) gyrated wildly last week. Many people viewed the stock’s rapid ascent as a David-versus-Goliath story: Tech-savvy individual retail investors coordinated their trades online to push up the price and “stick it to” large hedge funds that had shorted the stock. Sadly, the reality is very different.

Some retail investors in GameStop made money last week. But automated trading driven by AI now surpasses the speed and knowledge of most retail investors. I believe that wild swings in share price like the one driven by the GameStop crowd actually tend to result in a net transfer of wealth from retail investors to the hedge funds with the best AI teams.

Hedge funds that use AI to trade stocks make decisions based on a multitude of features including financial indices, social media chatter, and other forms of public or licensed data. Compared to a retail investor who reads r/wallstreetbets, they have access to far more information. They also have natural language processing and financial prediction tools to process all that information. Because of this, a typical human trader today can no more outperform an AI trader than beat a good reinforcement learning algorithm at an Atari game.

I differentiate between trading and investing. Human investors who choose stocks because they believe the underlying company is fundamentally valuable, and hold those stocks to realize that value, can do very well. Allocating capital to deserving companies can also help them grow, and thus make everyone involved better off. That’s different from trading, in which the aim is to buy shares solely to sell them to someone else at a higher price. Ultimately, trading creates little, if any, net wealth. When there are so many opportunities to grow the pie, why would we work so hard on activities that keep the pie the same size but squeeze out a bigger piece for ourselves at others’ expense?

In The Washington Post, Helaine Olen wrote about how the volatility in GameStop’s stock price wasn’t just the story of a get-rich-quick scheme. It was also a tale of inequality, as young people who can’t find a good job dream of gaming the system. I’m glad that some traders will use their GameStop winnings to improve their lives. But I am fearful for those who will lose their savings playing a game they’re unlikely to win. For example, those who bought at GameStop’s January 27 peak and might end up incurring substantial losses they can ill afford.

When you decide what AI projects to work on, I hope you will pick something that enriches not only yourself but society as a whole. Let’s also do what we can to make sure that whatever wealth we create is fairly and widely shared.

Keep learning!

Andrew

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