Asymmetric access to Information
Introduction
The most important element that moves the stock market up or down is information and many people trade based on information. The only problem is that not everybody has the best information or the latest information, not because they aren’t watching the news but because certain information is not publicly disclosed.
Example:
If you were privy to confidential information that Apple Inc was going to sign a deal with Facebook to make one social media platform, you would definitely buy some Apple stock and reap the benefits once the news was released or made publicly available. Well, this is precisely the problem. It’s often known as insider trading.
Insider Trading
Insider trading is an illegal practice in which a shareholder in a public corporation trades shares of that corporation using information that is not publicly disclosed.
Two types of insider trading:
Insider trading has two main types. The first type involves officers or directors of a company engaging in securities trading based on confidential information they get through their position in the company. The second type, referred to as the “misappropriation” theory, broadens the scope of criminal liability to consider external individuals who possess confidential information about a company.
In the second instance, the outsider gets insider information from a company officer by pretending loyalty to the officer or the corporation and then uses it for his own benefit. Insiders know information about the company that hasn’t been publicly disclosed which gives them the upper hand in trading and hurts small-time investors. For example: if company stock is expected to go up because of some new deal that hasn’t been publicly disclosed, company directors officers will buy more shares to make money as they already know the outcome.
You can read about an actual insider trading scandal regarding Todd Newman and Anthony Chiasson, who were two hedge fund portfolio managers. Newman had held a position at Diamondback Capital Management, while Chiasson held a similar position at Level Global Investors. Click here.
Insider Trading Ecosystem
It is reasonable to think that all the big investors are using some form of insider info to make these perfect trades. The investment banks, their wealthy investors, and the companies whose stocks are promoted on Wall Street are a part of a network of relationships which form this ecosystem. These relationships have led to an increase in selective disclosure, in which companies pass on inside information regarding themselves to favored stock analysts. The analysts then can alert their firm’s biggest clients before it impacts the company’s stock. Wall Street’s increasingly skewed analysts are in on this, which shows how deep insider information runs. Small-time investors, who have none of this information, are trying to make predictions about stocks.
Dark Pools
Another similar example of asymmetric access to information is Dark pools. Dark pools are trading platforms that facilitate anonymous matching of buyers and sellers. As a result, dark pools prevent large fluctuations in the stock market which would be caused if these massive trades were made public.
The problem with dark pools is similar to insider trading as the news about these massive trades taking place off the stock market is not known to the public but may be known to some people with power or good connections. This gives them an unfair advantage. Certain dark pools give off signals or indicators of interest regarding positions, which can be used by institutional investors to profit off of. This leads to more insider trading. Sadly, these signals or indicators of interest never reach retail investors.
Conclusion
Asymmetric access to information is a big problem for retail traders and the only way to steer clear of this problem is by doing your own due diligence: performing fundamental analysis and technical analysis. If you are a retail trader, buying a stock solely based on news may not be the best decision.
“If companies tell us more, insider trading will be worth less.“
~James Surowiecki
On to the next.
-Akash Gaonkar-
The financial advice provided is for informational purposes only and should not be considered as professional financial advice. Consult with a qualified financial advisor before making any financial decisions, as individual circumstances may vary. We do not guarantee the accuracy or reliability of the information provided, and we are not liable for any financial losses incurred.
