The role of an insider trading in stock market investing

Posted by adairsawyer on April 13th, 2013

The definition of an insider trading is pretty simple: a trading act conducted by a shareholder of a company, who uses inside information to decide in terms of stock market investing. If this is a good thing, a bad thing or a little bit from both we are going to determine together as it follows.

To put things simple, it all comes down to one major aspect: the nature of the information determining that trading. There are millions of people working inside these corporations. Does this mean that they are not allowed to invest in no matter what type of security? No, they can buy stocks and bonds but only if they do not use private information for this purpose.

With other words, let us assume that you are a key employee from a company that is going down. Only a few persons from the board are aware of the major difficulties of the company and letting other people know is not indicated for the moment. Supposing that you have access to that information, if you decide to sell your stocks in order to make revenues and avoid a potential financial loss, you become liable of illegal insider trading.

In any other context, being active on the market as long as you know just as much as your competitors know puts you outside of this risk. This is not just a rule dictated by common sense, but rather a legal requirement.

The field of stock market investing, just like any other field, needs this regulation in order to function by steady rules and to present credibility among worldwide investors. If we weren’t prohibited to trade highly sensitive information, anyone would have taken advantage in key moments and the market would have been highly impaired.

Now apart from the initially suggested term – public vs non public information, there is a second word we need to think of. What exactly is an insider? Is it enough to have some shares of that company? Is it a threshold that once reached makes you an insider? According to the legislation set up by Germany and United States, it takes owning a minimum of 10% from the equity securities of one specific class inside that company. Anyone from beneficial owners to directors subjected to this statute is considered an insider.

As a final major aspect, we should also state that there is a significant difference in between being closely involved with the board of a company and just getting a tip from the outside. Should you accidentally hear the news that a company is doing well and you decide to buy stocks before you actually have the information confirmed, you are not doing insider trading.

Consequently, one might say that there are lots of grey shades on this chapter. While there are a few specific facts that you must never forget, following your instincts is also one of them. And you should never feel ashamed of it.

 Any shareholder can be an insider trading at some point. And still, the way that he or she decides to use the information determines a legal or illegal behavior in terms of stock market investing.