Hacker News Reader

Comment by amalcon | Hacker News Reader

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.

View on HN

>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, 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.

> 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

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.

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?

Reply on news.ycombinator.com