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Comment by Taek | Hacker News Reader

Perhaps someone will change my mind, but I see the block on insider trading and spoofing as harmful to the financial industry overall.

Someone starts shorting a ton of Apple stock? That probably means something big is happen at Apple, and it's not good. It's information.

Spoofing as a technique can be used to combat and inhibit other types of trading, and is in some sense an algorithm to 'keep the opponent honest'.

As best as I can tell, the biggest reason that we as a culture are against insider trading is because 'it's not fair'. (happy to read a response that adds more depth to my understanding). It isn't fair, and the people with insider information are going to make a lot of money. But in the process of making that money they bring the information to everyone else. And insider trading incentivizes knowing as much as possible so that you can have an edge on the competition.

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The main reason we don't like insider trading is that we like participation in the market by relative amateurs. A system that allows insider trading discourages participation by amateurs, because they do not have insider information. Insiders would earn money at the expense of these amateurs, so it's better for them to stick to other sorts of investments to avoid this "tax".

This isn't necessarily a problem. As a society, we've decided that we like having amateur capital in the markets more than we want the improved efficiency of allowing use of inside information. It's a tradeoff, and while both options have their merits, society has chosen one way.

Would you say that barring insider trading is a way to encourage broader, shallower groups of investors so that the noise (as in signal-to-noise) caused by individual traders is smoothed out better?

If there were 1K inside traders who were the only profit-makers, would the price of a security be more volatile than if there were 100K "outside" traders who all had a virtually equal chance of profit?

> The main reason we don't like insider trading is that we like participation in the market by relative amateurs. A system that allows insider trading discourages participation by amateurs, because they do not have insider information.

While I agree with that in theory, in practise we see that the rest of the market is so hopelessly skewed in favour of insiders in one form or another it's like a sticky plaster on the stump of a severed leg; just look at the Facebook IPO, or high frequency trading.

HFT: I've never understood why stock is traded on a continuous time. In NYC there's a famous crossroad where banks have IT offices, because they want to be as close as possible to the stock exchange's servers, because 50ms latency difference can make them earn a few millions per year. If stock were traded discretely, like every 3 minutes or so, we would allow bids to pile up, and HFT and closer banks wouldn't have an advantage over more remote clients.

If stock were traded discretely, like every 3 minutes or so, it would probably reduce the effect. But a faster turn around would still be an advantage - right before the trade happens you can make up your mind based on more information than others have.

One thought might be to partly counteract that with a transaction cost that rises over the course of the 3 minutes.

> A system that allows insider trading discourages participation by amateurs, because they do not have insider information. Insiders would earn money at the expense of these amateurs

How so? Can you flesh out the scenario a bit since I'm having trouble seeing how this is the case. To me, it seems like if there were no trade prohibitions on insider trading the share price would immediately reflect inside knowledge, thereby protecting amateurs from making investments based on facts that they don't know that others do.

The share price likely wouldn't reflect insider knowledge. To see this, take an extreme example. The CEO owns less than 1% of most publicly traded companies. Even if he was allowed to sell his whole position without public disclosure, it wouldn't affect the stock price that much. Say he wakes up and finds out through insider knowledge that his company will go bankrupt tomorrow. He sells all his shares today. The stock drops a bit. It doesn't go to 0 just because he knows it should.

A stock price reflects a weighted average of individual investor's knowledge and their capital.

(Efficient market gets around this by assuming people are cool with not just selling the stock but shorting it all the way until it is as low as they think it should be. People don't tend to bet the farm (or have the ability to borrow funds to bet the farm) like that.)

But assuming that public disclosure was required for insiders, the CEO selling all their stock could drive the price down pretty quickly. People will be watching that particular 1% closely.

This assumes really fast turn arounds on this information.

There's time taken to submit data to a central clearing house and time taken for them to publish it.

Many people may not want you to have a real time feed letting people know what shares they have just sold.

There also exist accounting cycles and hence corresponding disclosure cycles. CEOs can make non related entity trades, mask trades, etc. Seasoned financiers are far smarter than the new entrant. They will find ways to reduce their "downside", and increase their upside.

You always want to ensure that new entrants are not left to the mercy and warm fuzzy feeling of finance experts. The rule is that they can't afford them.

>This isn't necessarily a problem. As a society, we've decided that we like having amateur capital in the markets more than we want the improved efficiency of allowing use of inside information. It's a tradeoff, and while both options have their merits, society has chosen one way.

I would imagine that information imbalance increases make a market less efficient, not more efficient.

> A system that allows insider trading discourages participation by amateurs

Not really, amateurs mostly make long term investments, they are not buying and selling based on quarterly reports. The only ones who would be affected by legal insider trading are the gamblers.

The thing that I think neither you nor this article get is that insider trading bans are criminal penalties that merely supplement a person's civil employment contract. That is, nearly everyone who is given insider information as part of their condition of employment is implicitly or explicitly given it on the condition that they don't exploit it.

I'm pretty radically against copyrights and such but I don't think anyone who wants a stock market can say that a corporation doesn't have the right to put limits on what employees do with information. And the first limit most anyone will put on information their employees are given is "no trading on it" - because the stockholders actually, oh, own the stocks and don't want random people profiting.

So insider trading is just broadly taking stuff you weren't given from work. If you make the situation purely civil, a few companies might even allow this but I don't see as a big selling point for their shares.

For the majority of companies, that wouldn't allow it, if there were no explicit laws against insider trading, profits from it could still be lumped under theft in civil lawsuits.

Yeah, usually there's defined windows in which employees can trade in the companies shares.

And apart from barring employees benefiting relative to other stockholders from additional information related to factors they don't directly influence, corporations also have to consider that executives wishing to actively influence stock movements to create insider trading opportunities will usually find it much easier to engineer an unanticipated dip in the share price than an unanticipated rise...

Insiders can create information as well as trade based on it, so there are very strong reasons for corporations to ensure they and their associates' potential gains from trade are very closely aligned with those of other market participants.

Allowing insider trading could also lead to much more "herding" behaviour: if the market starts moving before the official news event, it probably means someone (a big player) knows something, so everyone else is going to get on board the move. Now add a second order effect to this: people (big players) will try gaming the system by starting a herd effect before the big news. Especially if you make the herd go in the wrong direction you are going to win big time.

All of this leads to exactly the opposite of what you are hoping for: price discovery. It's just chaos and instability, and probably harmful to the market in general.

You are absolutely right. "Insider trading" is like the war on drugs.

Indeed, a slap on the wrist applied very rarely to those white collar criminals unfortunately politically unconnected to face punitive actions and another government initiative that also rarely applies any sort of punishment to the rich and connected.

Meanwhile, on the other side of the tracks - snatched some swisher sweets? That's a shootin. Sass me while black? That's another shootin. You got a likky stik of collie and minoritous in nature? You going down: hard!!!

> Indeed, a slap on the wrist applied very rarely to those white collar criminals unfortunately politically unconnected to face punitive actions and another government initiative that also rarely applies any sort of punishment to the rich and connected.

I don't believe this is even remotely accurate.

> Meanwhile, on the other side of the tracks - snatched some swisher sweets? That's a shootin. Sass me while black? That's another shootin. You got a likky stik of collie and minoritous in nature? You going down: hard!!!

I don't deal with sarcasm and vulgarity. If you want to make a point, make it politely and directly.

He's right though. Nearly a quarter of african americans in Florida are not allowed to vote - thanks in large part to the war on drugs, (well, and probably racism).

Meanwhile, relatively very few people go to jail for insider trading. The number of cases in the past 10 years is probably in the hundreds, possibly thousands. Compared to hundreds of thousands of drug cases (maybe millions?).

But they are similar in that they are both totally based on fiction. They are made up laws that serve no purpose.

(Except to employ enforcers---but that isn't why they exist. They exist because people believe the fiction.)

I should have been more specific about the intended nature of the comparison I was making.

OK, good idea. Let's make insider trading legal... now NSA employees win and everyone else loses. Seems like a sensible economic system.

You joke, but trading on insider information means revealing that information. It gives people 2 incentives:

1. Trade on your insider information quickly, or someone will beat you to it 2. Keep your secrets safer.

It also makes the NSA vulnerable to false planted information. Trading on stolen information means trusting that information.

> trading on insider information means revealing that information

Did I miss the blank space on the form that requires you to fill in the reason for your trade before it gets executed?

Joking aside, you do not reveal your intentions by executing a trade. Let's look at a hypothetical. Say all of the sudden someone dumps 5% of Apple stocks. Information has been imparted, but this is imperfect information. If you own Apple stock and you are weighing your options, you can't know the real reason behind these trades. If you did know the real reason behind the trades (e.g. announcement of a 1% dip in growth in Q4 2015) you could evaluate what you think that does to the value of the stock instead of trying to reverse engineer someone else's logic.

Another Example: How about knowing that someone will happen in ~2 months time, so you slowly sell stock off over 2 months. How does this impart significant information to the market?

>You joke, but trading on insider information means revealing that information.

Are you joking here? Let's say, hypothetically, Apple CEO buys a lot of stock today. When you learned that fact, did you learn the facts that motivated him to buy the stock? NO. Absolutely, purely, unarguably NO. Not unless you spoke to him directly and he told you.... truthfully.

This is not a joke. The NSA, or any spy, having access to "all" digital information, can easily differentiate between false and true information, or at least have the opportunity. But you, as an individual, can only act on what is shared directly with you. Making trades does not share any information beyond the fact that the trade was made.

"When you learned that fact, did you learn the facts that motivated him to buy the stock? NO. Absolutely, purely, unarguably NO."

A more charitable (and, as it happens, accurate) reading of the parent's comment is that trading on insider information means revealing some of that information. It's obvious and unarguable that this is not all of that information, but as I've said in other contexts, you're always leaking more information than you think. It's often surprising what can be inferred when a few pieces of information are combined.

It's harmful to the industry overall, since it prevents people from executing trades to help correctly price companies.

We should still discourage and ban it. Outside of what the market as a whole does, there's still the question of who benefits from it. Insider trading incentivizes some shitty behavior and some pretty major principle-agent problems.

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