What is Machine Learning? A Simple Explanation for Finance and Business Professionals

Machine learning has become a important tool in finance since it has transformed how we analyze data and make decisions in financial markets. Machine learning is often deemed as "complex" but the basic process of how models are made is straightforward and similar to how financial models like DCF are made in the world of finance. Machine learning is basically a way for computers to learn from data and make decisions without being explicitly programmed. When creating machine learning models there's a seven step process involved: 1) Collection of data: Just like in finance, where the quality of your data can make or break your analysis, the same goes for machine learning. The initial step involves gathering relevant data. Example of relevant data for a financial AI model could include data such as historical financial records to real-time market data. This foundational step sets the stage for the effectiveness of the model. 2) Data Preparation: Once we have our data, the next step is to refine it. This involves cleaning the data to ensure accuracy and consistency, much like auditing financial statements. It's about making sure the data is in a format that a machine learning model can effectively use. The same way an analyst won't give a portfolio manager an 80 page SEC filing is the same way we don't give our ML model a bunch of nonsense data. 3) Feature Engineering: Think of this as similar to identifying key financial indicators. We modify or create new data points (features) to enhance the model's ability to make predictions. It's like adjusting financial models to better predict future market behaviors. 4) Model Selection: Here, we choose the mathematical model that best suits our data and objective. In finance, this is like selecting the right investment based on the market and economic indicators. We often rely on proven models rather than creating new ones from scratch. For example if you wanted to create a model for stock price prediction you would use a time series forecasting model like Prophet by Meta. 5) Model Training: This is where we train our model on the data, similar to how we might backtest a trading strategy to see how it would have performed historically. It involves setting up an efficient process for feeding data into the model to optimize learning. 6) Validation: After training, we test the model using new data to check its performance. This step ensures our model is reliable before full-scale deployment. 7) Model Persistence: Finally, once we're confident in the model's abilities, we save and perhaps deploy it for ongoing use. This is how machine learning models are built and used, from solo developers to big companies like Google or Microsoft. These steps ensure that the models work well and can grow with time.