Definition: Insider trading is the purchase or sale of securities by individuals, usually brokers, who have access to price sensitive information that is not readily available to the public, and are exploiting this information for personal gain.
What Does Insider Trading Mean?
What is the definition of insider trading? Insider trading includes transactions that aim to personal gain or to avoidance of personal losses. Conversely, it does not involve transactions, which are made based on external information, such as knowledge about upcoming changes in the market legislation or technological developments that will affect an entire industry. Insider trading is generally negative and related to knowledge that is acquired from inside.
Let’s look at an example.
Example
Any leakage of a financially sensitive information such as the intention of a company to proceed with a takeover or a merger with another company, a profit increase announcement, information on changes in the dividend policy, a rise or fall in the degree of creditworthiness from rating agencies, all is considered inside information.
For instance, a member of the board of directors has inside information that the company will announce a merger over the next couple of days. So, he buys 5,000 sharesof the company in his spouse’s name and realizes a profit before all other investors learn about the merger.
To consider insider trading as an illegal action relates to when the inside trader has made the transaction. If the information is not public when the transaction takes place, then insider trade is illegal because the insider trader has gained an unfair advantage over the rest of the investors. Conversely, if the information is public, then the insider trade is not illegal.
For instance, a government employee hears that the senators are about to pass new legislation that will be beneficial for the shipping sector. So, he buys 3,000 shares of a shipping company and pushes the legislation to go through as soon as possible.
Nevertheless, the legalization of using non-public information for conducting a transaction will hurt the transparency and credibility of the capital market as investors, due to the unfavorable position compared to insiders, will not be interested in investing in the market, thereby reducing its liquidity by withdrawal.
Summary Definition
Define Insider Trading: Insider trading means an investor buys or sells securities and makes investment decisions based on information that isn’t publicly available to other investors.
