The financial market is a vast market, with industries such as forex, cryptocurrency, stocks, and bonds valued at trillions of dollars.
As a result, in an industry like this, there are aRe always people who try to cheat and achieve a strong return. One of these methods is known as Insider trading.
In this article, we will explain what insider trading is, how it works, why it is illegal, and how to avoid it.
What is insider trading?
Insider trading is defined as a situation in which A person buys assets using material, non-public information. This information can have an impact on the movement of assets.
A good example of this is A Hedge fund receives material information such as profits before Results released to the public.
In this case, the hedge fund will be able to place its trades in anticipation of the official release. If the company achieves strong results, the fund will open a buy position. On the other hand, if a company posts poor results, the hedge fund usually opens a sell position.
In general, insider trading is considered mistake Because he It gives an advantage to a small group of people at the expense of the broader market. This happens across all industries but is most common in the stock market and cryptocurrency.
Is insider trading illegal?
Yes, insider trading is illegal in most countries. Regulatory agencies have created laws that prevent people from using material inside information without due process.
in the United States of Americathis practice It could lead to years in prisonlarge fines, and even expulsion from the financial industry.
According to the SEC, the maximum penalty for insider trading is 20 years. For an individual, the maximum fine for this fraud is $5 million, while for entities such as hedge funds, the maximum fine is $25 million.
Furthermore, individuals who engage in insider trading can be banned from the financial market forever or for some time. Meanwhile, the person providing these materials may have to pay more than $1 million in fines.
How does insider trading work?
Insider trading It often takes many forms In the market. more common approach where A rogue employee works with a player in the financial industry. In this case, the employee will often Provide information about the company to the trader, who will then use it to execute trades.
The other way insider trading works is where a Senior management of the company Works with traders and investors. These entities then cooperate in a way that benefits the trader.
Another gray area concerns Policy. In the United States, members of the House of Representatives and the Senate are allowed to trade stocks. The same is true of officials at the Federal Reserve.
Therefore, these people tend to be possessive Material information that can affect the financial market. For example, it was widely reported that some politicians threw stocks in March 2020 before Covid was declared a global pandemic.
Examples of insider trading cases
There have been many cases of insider trading. The most popular is The Steve Cohen caseone of the most famous hedge fund managers in the world.
He was once a top performing manager through his company, SAC Capital. US prosecutors sued his company for insider trading and ordered him to stay out of the industry for a few years. He also paid a $1.8 billion fine to the organizers.
Another good example is Raj Rajaratnamanother hedge fund manager who was sentenced to nearly ten years in prison for market fraud.
How to use inside information legally
While this practice is illegal, there are many tactics that traders use to profit from these activities.
Insider stock sales
One of the best ways to use inside information legally Check the actions of company insiders. In the United States, directors and directors are mandated by law to ensure that all stock purchases and sales are reported.
So, if you take the time to track the company’s internal transactions, You’ll be fine To see if the company is a good buy or not. In most cases, insiders tend to buy stocks when they think a company is doing well and vice versa.
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There are many examples of this. For example, it was reported that Silicon Valley bank insiders had dumped their shares before the bank collapsed.
There are other examples of a situation where executives sell stock before a major event. For example, CEO and family of Ernie Garcia, The dominant Karvana familyShe sold billions of dollars in stocks before the stock collapsed.
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Another way to legally circulate inside information is to use politicians’ disclosures. in the United States, Politicians wanted By law to ensure that they Post their belongings periodically. In some periods, you can keep track of the stocks they are buying and investing in.
However, the challenge here is that those Disclosures tend to be a bit late Because they are required to disclose it every three months.
Another way to use inside information legally is to perform an in-depth analysis of key assets using public materials.
For example, for e-commerce websites, you can use platforms like LikeWeb to check the number of visitors to their websites and those who download their apps.
The same applies to cryptocurrencies. For cryptocurrencies like Ethereum and Solana, you can track the activities of the largest players in the ecosystem using on-chain analysis.
How does insider trading affect the markets
The fact is that practice It tends to benefit a few people at the expense of the market. Here are some of the most important ways that insider trading affects the markets.
Loss of confidence in the markets
The most important consequence of insider trading is that it It affects the general confidence among market participants.
A good example of this is the penny stock market, which has a large percentage of insiders. In most cases, many people have completely avoided the small-cap stock market in the industry.
Unexplained market movements
Another consequence of insider trading is that it leads to Unexplained market movements in the stock market.
As a result, it can lead to big profits for a small group of people at the expense of most traders.
Insider trading can lead to a Significant reputational damage. In many cases, good businesses that have been in the business of insider trading tend to be irreparably damaged.
Also, these companies tend to underperform in the market.
questions and answers
Is insider trading illegal?
Insider trading is illegal in most countries, including the United States, Canada, and Europe. In many cases, it was people He had to pay huge fines And some were prison for years of insider trading. As a trader, you should always avoid getting caught up in these activities.
How is insider trading detected?
For most people, it is Relatively difficult To uncover insider trading. One of the easiest ways to spot them is to check if they are buying or selling stocks. The challenge with this is that these deposits tend to be delayed for some time.
When is insider trading legal?
As mentioned, it is possible to use insider trading legally. This is where you are Use your skills to find information It can affect company stocks such as internal sales.
Useful external sources
- Insider trading policy – SEC