What Is Insider Trading?

Trading is a zero-sum game. And not just a few times, but almost all the time, the ones who get trapped on the "zero" side are the retailers. There is a very famous saying in the market, "once you see retailers flocking up on a particular scrip, you should start leaving the place". This is because, by the time small investors come to the party, it's already over. And this largely depends on the fact that retailers lack the inside information which professionals have. So, what is this inside information we are talking about? And what is insider trading, and why is it banned in almost every country? Today, we will focus on these points and explore the unethical activities in the financial markets.

Material Non-Public information

Material Non-Public information can be news related to a company that has a very significant effect on the shareholders and has not been disseminated to the public. Now, anyone who has invested a significant amount of money in a company would always want to keep an eye on the happenings in the management meetings. Sometimes, few events or happenings are kept a secret till management feels it is a good time to give the information to the general public. This can be anything like a new merger deal or a new product launch or any product failures or demerger news etc. It can be anything. So, being a small investor who never attends the general meetings of the management and doesn't have any connections high up in the company would never have this inside information.

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What is Insider trading?

People, and by the word "people" we mean the ones who work in the big investment banks or brokerages or advisory firms, etc., have information related to companies before their announcement. For example, company X has invented a medicine that can cure any type of cancer. The management is holding this huge information within themselves because they are awaiting the clinical results, which will come in a few weeks. Just imagine how big this news is. A person who knows this information prior can easily go all-in in the stock and realize a humongous profit once the management announces the news. Since price would touch the sky as this is a lifetime awarding product that would change the company's revenues forever.

However fantastic this may sound to you, it is highly unethical to hop on these types of trades as it is called "insider trading". This means trading based on insider news which has not been made public at the moment. Someone big money would take positions beforehand and, when the news is made public, would make use of the huge liquidity inflow to dump their stocks on the retailers who jumped to buy the stock. These types of events happen daily, and prices always go in the opposite direction to what is expected. You can easily deduce that who loses money here? It's the retailers. Who was baited? It's the retailers. Who profited the most? The unethical big people. And because of this same reason, insider trading is banned in many countries.