AI stands for "Artificial Intelligence." Artificial intelligence in Super Smash Bros. Melee refers to the intelligence of any computer player in vs. mode and 1p mode. In vs. Mode you can set the AI for a CPU, and in Classic mode, Adventure Mode, and All-Star Mode you can set it to some degree.
AI levels range from 1-9. Level 1 being easiest, level 9 being hardest. Beginners tend not to realize that the best way to practice against a computer is to fight a level 1. The reason for this is that the higher the level, the weirder and spammier the play style. They also have much worse DI. Level 9s fight like no human ever will, so it's giving you the wrong kind of practice. For best results, fight against a level 1 and practice combos.
One of the complaints about SSBM and SSB is that the AI is really bad. There are multiple glitches with the AI and many of them can be seen on Youtube. Examples of Bad AI:
SSB(64) featured rough AI with flaws such as poor recovery abilities and using the same ineffective move over and over again in quick succession.
Most opponents will use their neutral "A" move repeatedly, and are very easily edgehogged.
Certain stages are notorious for their bad AI players, such as Rainbow Cruise and Final Destination. Congo Jungle is the best known poor AI stage, as it is easy to KO AI by simply grabbing an edge, dropping from the edge as they attack, and then re-grabbing the edge.
The AI on Melee make poor use of their shields, and use grab attacks far more often than normal attacks.
In Brawl, the AI is decent, but it has limitaions. Like the original, the default level for computers is 3, unlike Melee, which was 1. Certain characters (namely Ness) know how to use their recoveries more efficiently in Brawl. If a character gets an item like a Starman, rather than just trying to avoid that character, they'll also use the opportunity to attack any stragglers. When a Smash Ball appears, opponents will aggressively attack it at opportune times, while repelling anyone who tries to get it as well. The AI in Training Mode is also improved drastically, as opponents set to Attack will actively fight the player, rather than walking towards them and rarely throwing an attack like the previous games. One change from Melee is that AI players seem to focus more on attacking human players than each other.
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