
Learning to Love Insider Trading - splat
http://online.wsj.com/article/SB10001424052748704224004574489324091790350.html
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shimon
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?

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

~~~
joe_the_user
You can't necessarily separate those two elements.

Further, there have been a number of articles here describing exactly how
High-frequency trading gains an information edge - among other strategies, by
"tasting" orders, the machines can discover demand without making investments
and then front-run the demand.

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byrneseyeview
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.

~~~
codeslinger
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.

~~~
btilly
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...](http://economics.about.com/cs/macroeconomics/a/logic_of_action.htm).

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maxwell_smart
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.

~~~
codeslinger
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.

~~~
maxwell_smart
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.

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smhinsey
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.

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

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

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lionhearted
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.

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neilk
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.

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anamax
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.

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known
if you can't beat them, join them

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

