Learning to Love Insider Trading

http://online.wsj.com/article/SB10001424052748704224004574489324091790350.html

by splat • 17 years ago

17 21 17 years ago

online.wsj.com

smhinsey• 17 years ago

Perhaps I have become too cynical over the past several years, but to call this naive seems almost too charitable. As a physicist might say, this is not even wrong.

codeslinger5• 17 years ago

It is this kind of ad-hominem attack that turns great conversation forums into immature wastelands. Let's not allow that to happen here.

neilk2• 17 years ago

That wasn't an ad hominem. The commenter called the idea naive, not the writer. The point does need more support though.

lionhearted• 17 years ago

I always thought insider trading with full disclosure as to why and a time lapse should be okay. I think the following would both be fair and good for the world:

1. Let a member of the company announce their intention to buy in one week while disclosing their full reasoning. So make any information they're trading on public, and wait a week for the market to act on the information.

2. Allow a member of a company to leave a public, standing order of, "I intend to X shares of our company's stock if the price drops below $Y per share."

Those seem like they'd be good for the markets rather than bad.

maxwell_smart2• 17 years ago

Wow. I remember that back in the day, it was commonly argued that derivatives trading would reduce volatility in the markets. This is no different. Under certain assumptions, insider trading would lead to a more efficient market, and under others, a far less efficient market.

Quick question: which of these scenarios do you think captures the mentality of an inside trader?

A: I NEVER hold shares in companies that I do not fully believe in, and I ALWAYS take a long position. If I get inside information that a company is in trouble, I will immediately liquidate my position-- it may not blow up on me today, or tomorrow, or even this year, but I trust that sooner or later the stock price will take a dive, and I want to be long gone when that happens.

B: I have inside information that a company is in trouble. I don't know when it will blow up, but I do know that I have an edge on everybody else who doesn't know what I know. So, I should ride the stock all the way up, as long as it keeps going up, and short it on the first sign of trouble on the technical indicators. This way, I can make my money on both ends-- the up and the down.

One of these strategies will act to reduce volatility, and the other will enhance it.

codeslinger5• 17 years ago

The problem with your assessment is that it proves Don's point in the article. The B trader will reveal his inside information much more rapidly than if he were not able to act on it, thus increasing the amount of information available to the market as a whole, enabling better decisions by others regarding the security in question.

I agree, the "B" traders are more likely, but that's a good thing.

btilly2• 17 years ago

More problematic are the "C" traders. People with access to inside information who therefore believe that they'll get news of things that will shift prices before anyone else. These people are then able to take risks and time more aggressively, trusting that they'll be able to jump ship at need. These people therefore avoid revealing inside information until the last possible moment.

But the real trouble is the "D" traders. People with no access to inside information who have no interest in providing excess rents to traders A, B or C. When this group of people gets the impressions that the real gains in stocks go to insiders, and outsiders get the shaft, they stay away in droves. In fact the desire to encourage this group to invest is one of the primary reasons for the insider trading laws in the first place.

maxwell_smart2• 17 years ago

I don't follow you at all. If the information available to the market is provided at the point the insider executes the "sell" then it is the B trader who provides his information later, and all the B traders will tend to act nearly at once.

In the A scenario, the A traders sell immediately, and act upon receipt of the inside information, rather than react to each other, so the information is furnished to the market gradually by all A traders.

Please tell me in more detail what you think of the scenario that I posed, and how it makes the point of the article.

byrneseyeview• 17 years ago

Many of these justifications are unrealistic. If insider trading is common, someone without insider knowledge will assume that the counterparty to any trade they make is better-informed; their best option is to find markets where insider trading is difficult.

There's a reason exchanges used to frown on this sort of thing even before it was illegal. It's better to have a market where differences of opinion on publicly-known facts are the only reason to trade -- a difference in available facts will make people reluctant to trade at all.

codeslinger5• 17 years ago

There is a technical term for this phenomenon: an Akerlof market. Where there is a large information asymmetry in favor of the sellers, the price of items in said market is driven down since buyers will not pay the sellers' requested prices due to high variances in quality. "Lemon laws" are an example of a countermeasure against an Akerlof market developing for used cars.

More to your point, if insider trading were common, as you propose, then the prices of these transactions (and therefore the profit gained from them) would begin to fall as buyers would increasingly begin to distrust said transactions. Therefore. it would be in the best interest of traders with inside information to not act in the manner in which you suggest lest they significantly deflate the market from which they are looking to extract profit.

btilly2• 17 years ago

While it is in the long run interest of every inside trader for all other inside traders to restrain themselves, it is in their very direct personal interest to extract maximum value from their knowledge. Furthermore it is difficult if not impossible to for anyone else to know that the inside trader was acting on inside information. Therefore you can't get them to cooperate for their general good.

For much more on why groups fail to act in their self-interest I highly recommend The Logic of Collective Action by Mancur Olson. You can read some of the main points at http://economics.about.com/cs/macroeconomics/a/logic_of_acti....

shimon• 17 years ago

The author doesn't seem to consider that legalizing insider trading would provide a huge incentive for insiders to conceal information from the general public, so that they and their cronies can act on it before the general public.

Of course enforcement is imperfect, but is a price change due to insider trades really more informative than an earnings announcement heard by just-about-everyone and just-about-the-same-time?

codeslinger5• 17 years ago

This is already the case and happens all day every day, although it goes by the name "high-frequency trading". The information that HFT systems trade on is "concealed" via the latency differences between multiple systems interacting with a given exchange(s). This "latency arbitrage" can be understood to be an extremely high-speed version of insider trading.

quizbiz• 17 years ago

High-frequency trading is a game of speed/efficiency, not of information/analysis.

nandemo• 17 years ago

This has nothing to do with high-frequency trading.

Insider trading has to do with with knowledge of important and undisclosed facts about a company. Stuff that, when disclosed, might cause price swings (several percentage points).

HFT works with disclosed information: prices and order books are public. Just because someone has access to this information 10 milliseconds earlier doesn't make it "insider" info. Also, HFT profit margin is usually tiny (measured in basis points).

You're stretching the definition of "insider trading" so much that it's almost meaningless.

mattiss• 17 years ago

What a stupid idea. How does WSJ publish this crap?

known• 17 years ago

if you can't beat them, join them

anamax• 17 years ago

Many of these comments make assumptions about "insider trading" that aren't true. See http://en.wikipedia.org/wiki/Insider_trading

For example, it looks like Google can trade Rackspace stock based on its private knowledge of pending deals with Rackspace, such as whether it is going to sign one. Google's employees can't.

neilk2• 17 years ago

The author's theory depends on the notion that markets are extremely efficient at disseminating information. Even information that traders would like to conceal. But this theory is under increasing scrutiny. You yourself might have noticed a few mispricings in the stock market lately.

Even Eugene Fama, the guy who coined the phrase "efficient market", now believes that it won't work in exactly the case the author describes. A few arbitrageurs in a very misinformed crowd won't correct the price.

Anyway, I know all this because I just finished the book The Myth of the Rational Market, by Justin Fox. It's the biography of the idea, from a tentative observation to dogma to just one tendency of the market among many.

At least the way Justin Fox tells the story, the stronger versions of the efficient market hypothesis just don't have a lot of evidentiary support anymore. Yes, markets try to get it right. But they can be persistently wrong in ways that efficient-market theorists think should only happen once in hundreds of thousands of years. This has happened multiple times just in the last 20 years.

Perhaps that information hasn't been efficiently disseminated to the WSJ yet.

Learning to Love Insider Trading

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