Inside traders are not always employees. Inside traders are just individuals who are able to acquire intimate information on a certain company. They could be personal friends, lawyers, stock brokers, CEOs and other high officers in a company. Inside trading doesn’t necessarily hurt a company, either, except if the company is trying to commit fraud by making their stocks reflect a sign of high health. But, those with information on a company’s impending bankruptcy or anything that reflects negatively on the health of company are bound to sell their stocks; as prices go down this will signal to others to sell their stocks.
I’m not sure what you consider being “caught” is. Usually, high officers of a company will reap large incomes from selling stock early, because they know better than most other people on the true state of the health of the company. This is seen as immoral because CEOs can “drive their company into the ground” and still make large incomes. But, the fact of the matter is that even if the CEOs weren’t to sell their stocks based on intimate information, most people will still lose out and would probably lose out more. The inside traders revealed the true state of the company’s financial health much faster than it would have been revealed otherwise.
So? How would it be different without the inside trader? Or, do you prefer not to know about the price drop and instead continue to buy the stock at high prices, and lose even more money in the future? How a person reacts to the price mechanism is subjective, but it nonetheless stands that inside traders do you a favor by causing a drop in the price before the price of the stock is bid up even more by malinformed individuals.
People speculate no matter what information is provided by the price mechanism. That’s the nature of the stock market. Do you want them to speculate on false information, or based on no information at all?
yes, this is how the market is coordinated. By prices.
Nobody thinks anything like what you’re describing. Some stock holders with better knowledge think $40 is overvalued so they attempt to sell. If they get a buyer for above their minimum selling price, they will sell. That is all.
Your question has nothing to do with inside trading but with prices as signals in general. particularly to the capital markets.
My point is without insider trading the price would be much more stable at say $40, even if this is a malinformed price. Then when the inside information becomes public, the price will drop down to around $20 and remain faily stable around that price. To me that is more preferable then having wild swings in prices as a result of speculation of insider trading. I think having the stability will attract more liquidity, make it easier to calculate, and improve the quality of the market.
Anyway, I’m not married to my position, I think you make good points. This is why I asked the question, to try to flush out my own belief on the subject.
I’m not sure why you have an obsession with price stability in the stock market. The price of a company’s stock should reflect that company’s general health. If a company begins to take losses then it’s expected that the value of its stock will decrease, as less investors are willing to risk their money with that company (if a company is losing money so are the stockholders, or investors).
Inside traders preform a valuable service by conveying the information they know on the company’s general health through the price mechanism.
“Inside information” only becomes public once that information has been conveyed. This is usually done through an inside trader.
Inside trading does not cause “wild swings”. The only reason why a stock would take a huge hit is if there is a threat of bankruptcy or huge financial losses. Prices fall quickly because inside traders will tell other day traders, who then opt to sell their stock as well.
What stability? If the stock value is delayed from adjusting to a more realistic reflection of the firm’s ability to make money in the future, how does this improve stability or calculations? On the contrary, people continue to act upon the false information that the stock value is signaling. Ultimately, the real state of affairs will be revealed, but only after the value of the stock continued to go in the wrong direction for a prolonged period of time. All this because those with the most knowledge are prohibited from acting on their knowledge.
I could be wrong, I haven’t done any research, but as an investor I would prefer to invest in less volitile stocks. If all investors hold the same opion I do, then there would be a greater quantitiy of investment (lower spreads, higher prices) if markets were less volitile. You seem to be under the assumption that given insider trading, non insiders would sit back and just say “Oh, the price dropped. How bout that.” No, there would be alot of speculative activitiy on the part of investors. With many people with different forms of information, the price would be all over the place. With a ban on insider trading, everyone has access to the same information, thus less price volitility.
If you can prove to me that insider trading will not cause more volitility and thus less liquidity, then I will take your position. So far, you haven’t done that.
Well, you want to invest in stocks that will rise in price, so that you can make a profit. You absolutely don’t want to invest in a stock which you buy at a high price, expecting it to continue to rise, only for the price to suddenly fall. This is why inside trading is valuable to you; it sends you a signal through the price mechanism that the strength of the company is not reflected accurately by the current price of the stock.
You are working under the assumption that inside trading causes volatility. It does not, otherwise the stock market would always be rising and falling wildly. Inside traders usually only cause big changes when a company is revealed to be either financially bankrupt or about to hit gold. That said, the price of stocks always falls and rises at small increments - this is just how the stock market works.
No we aren’t. We are clearly working on the assumption that inside traders send a message to other day traders by selling their stocks and causing the price of the stock to decrease. Other day traders act on this information.
Err, even without inside traders trading in general has different people with different information. Inside traders just provide more information to these same traders through the price mechanism. This is how the price mechanism works. This is how the market in general works. Have you read Human Action?
Lack of liquidity is what causes increased volatility, and not the other way around. More agents expressing their view on an instrument, by definition, increases liquidity. Draw the inevitable conclusion on volatility from there.
This is an important point. I’d like to quote from my article on the recession of 1937:
All that was necessary was a catalyst to bring about a slowing in the pace of credit expansion. This was provided by the stock market. Heavy regulation in the years leading up to 1937, including heavy taxes and legal impediments on inside trading, reduced incentives to invest in the market.
The result was a stock market in which a large proportion of shares were held by a relatively small pool of investors. This naturally “thinned” the markets, meaning that minor changes relating to buying and selling could reflect dramatically on the prices of individual stocks.*
See if I’m a day trader without inside information. .. I’m not going to see the stock price go down and say…o that must be inisders conveying information to me. No I’m going to crunch my numbers again and determine the risk of the firm has not changed, but now it is cheeeper to buy. Thus it is a bargin for me. Same level of risk, higher return. Without that inside information, obviously i’ve got a problem. I can either go with the information I know, or I can speculate as to the reason the price fell. The question is …will I be more or less likely to want to invest in this environment.
*****Just a side note…I’m not making this up…as we speak I’m sitting in class - financial institutions and markets…and my professor, who used to work for the SEC (i know that hurts credibility more than it helps) started talking about insider trading, and I just raised my hand and asked if insider trading would make spreads go up or down. His answer was essentially…insider trading would result in higher spreads. But since its hard to police, the market already accounts for insider trading in current spreads, thus if insider trading were legalized he said we wouldn’t expect much of a difference in spreads.
But my point holds, if you could eliminate insider trading - spreads would go down.
If you already have shares in that company you are taking a loss, and so the signal that drop in price will send is completely different. As a day trader, I hope you aren’t valuing stocks at the current price, as opposed to the current price relative to the last price. Day traders are interested in making money, so they generally opt for stocks which value is increasing, not decreasing.
You are less likely to invest in a stock with a falling price, for good reason.
I’m still perplexed on how you believe “inside information” will be spread equally amongst all traders, or spread at all until all investors lose equally.
The bottom line is that there is nothing wrong with making informed decisions regardless who else has that information and accurate speculation as a rule decreases prices fluctuation.
It is considered legal in Italy and Switzerland (pretty sure).
Because it is seen as a more accurate representation of the truth worth of the company… if its employees are selling, then time to get out, if they are buying.. well analyse yourself and get on board.
Here’s the thrust of the arguement. We have two senarios…1. Everyone has the same information. 2. Some people have information that others don’t have.
Ultimately whether the market would be more effecient with a ban on insider trading would come down to if people prefer senario 1 more than senario 2. If they do, then there will be more investing, better market quality. If they don’t then insider trading would probably be preferable. I’ll leave it at that because we probably will never know unless the state collapses and we can experiment with other systems.
If there is one thing you should learn from Keynesian theory it’s the concept of asymmetrical information. Then again, the Austrians recognize asymmetrical information - or imperfect distribution of information - they just realize that it’s not harmful and doesn’t cause disadvantages… quite the opposite. Markets do not operate with perfect information, and this includes the stock market.
Whether inside trading was banned or not, investors would still work with differences in knowledge.
Inside trading is beneficial with or without the state. [:S]
Clearly I didn’t mean everyone has exactly the same information, but rather acess to the same publically available information - same financial statements, same press releases, etc.
I’ve been linking this a lot today, but I would suggest reading Lucien Albert Hahn’s book Common Sense Economics. He dedicates an entire chapter to the stock market, including on how the price mechanism works. Until you understand the role of prices in the stock market it seems that all of our arguments are falling on deaf ears.
You keep falling back on this mythical notion of perfect and fair information, and price stability. Prices are never stable in the stock market. They are either increasing or decreasing. Traders make investment decisions by deciding what stocks have a higher probability of garnering returns on their investment. They make these decisions based on the price mechanism. Inside traders provide valuable information through the price mechanism by revealing the true state of a company’s finances (a company’s finances can change in a matter of hours or days, while financial statements et. al. are only provided periodically, it therefore remains nonsensical for a day trader to rely only on periodic information).
The entire question of the morality of inside traders lies in the fact that those who did not profit or lost money are jealous of the fact that the inside traders were able to sell or buy their stocks first, therefore garnering the largest advantages. There is nothing immoral about this, and it actually works to the advantage of the other day traders as I have already expounded in the posts above. If it wasn’t for inside traders, other day traders would have no inkling on the true status of a company’s health until it was revealed at some periodic point in time, at which time the stock would have already lost all of its value anyways.
I suggest the following articles, as well:
Machan, Tibor, “What is Morally Right with Insider Trading,” Public Affairs Quarterly
It’s very important in the world of finance that shares be accurately priced. There are many things that turn on that – compensation does, the whole takeover field turns on it, people’s investment decisions turn on it, so it’s very important that we have actual reflection of what’s going on. Well, how do you get that? The SEC says, well, we’ll get reports that come out three or six months later, and that will inform the market of what’s going on. That’s baloney. The way the market works is that informed people do their trading, and every time they trade on good news, they drive the price up – every time they trade on bad news, they drive the price down.
My gut tells me that seeing the CFO buy shares hand over fist in a small-cap company is more useful than knowing the sell-buy ratio, as computed by Vickers, is 3.51,
Honestly, you and I are debating two separate issues. I think we got way off track talking about price. Stock prices are irrellevant for the purpose of the this argument. What is relevant is the quantity of investment. If people trade with others who have superior information, this increases uncertaincy beyond the normal uncertaincy surrounding securities. More uncertaincy mean higher bid-ask spreads. Insider trading may lead to a more accurate price, yes, but may also lead to a higher spread and this is damaging to the market.
Insider trading might not result in lower spreads, I really don’t know. My professor just said twice tonight that it would, but I’m still not sure.
But the argument that insider trading makes the stock prices more accurate (which you are right about) says nothing about spreads or liquidity. Which is what I was addressing with this post.