Definition of Insider Trading





What is "insider trading"? What is the definition of the term "insider trading"?

"Insider trading" occurs when a person attempts to profit from their knowledge of non-public information.

In theory, every investor is entitled to receive information about a company at the same time. So, in theory, a well-connected investor with billions of dollars should not have an informational advantage over an investor with just $10,000 in their Ameritrade account.

Examples of Insider Trading:

Insider Trading - DefinitionExample #1. Joe Smith works at XYZ, Inc. Joe Smith noticed a memo on his bosses desk that discussed the pending acquisition of ABC, Inc. by XYZ, Inc. Joe Smith immediately went home and purchased 10,000 shares of ABC, Inc. in order to profit from his knowledge. This is insider trading.

Example #2. Mike Smith is a reputable and well-followed analyst. In order to earn some extra money for himself, Mike Smith decides to enter into a profit-sharing agreement with one of his friends who is a hedge fund trader. Smith will tip off his friend in advance of any upgrades or downgrades that he is planning on releasing, in exchange for a cut of the illicit profits. This is insider trading.

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This is Not Insider Trading:

Example #1. Jill Smith is a hard-working investor who enjoys doing due diligence on the companies that he invests in. Smith travels around from mall to mall, asking retailers if they are selling any of XYZ, Inc.'s new product. The answer is universally the same - the product is not selling well. XYZ, Inc. has put their entire future on this product, so Jill Smith decides to initiate a short position in the company. This is not insider trading.

Example #2. Jill Smith notices that put buying volume has greatly accelerated in front of XYZ Inc.'s quarterly report. Using this information, Smith decides to initiate a short position on the off chance that XYZ Inc. misses their earnings. Indeed, XYZ misses their earnings by a mile and plummets in value the next day. This is not insider trading.




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