Insider Trading Explained

Olymp Trade Team

Definition

The legal definition of insider trading is buying or selling a security in breach of a fiduciary duty or other relationship of trust and confidence on the basis of material, non-public information about the security.

This definition speaks about a person who enjoys a «relationship of trust and confidence»‎. In the commercial context, that means a person knows something about a security that is supposed to stay “non-public” either for a while or forever. In other words, he knows the corporate secret and can use it for insider trading stocks.

At the same time, such a person has a «fiduciary duty»‎. That means the company and the shareholders trust that individual, and he has a duty to be loyal to them by putting their interest first. So, he is entrusted with keeping that secret and not using it for his personal interest.

Finally, the definition says «material»‎ information. That may be information about the corporation’s planned merger, investment, performance, important contract or appointment, change of strategy or anything else that may impress traders and investors. This separates the price-relevant information from any other information about a stock that may also be non-public but bear little threat to the stock price.

Now, does knowing and being entrusted with corporate secrets make one an insider? Not before such an individual breaks that trust and possibly the law.

Logic of Legal Insider Trading

Not all insider trading is illegal. See the examples below.

• A CEO of a company may buy or sell his company’s stock. That will be legal as long as the CEO notifies regulators of the transaction and makes it public.
• A board member of a corporation may increase his share of that corporation. That will be legal if the regulator is notified.
• An employee can realize his company’s stock options and buy stocks of the same company. That will also be legal.

All these cases have something in common. That is, trading decisions are based on publicly available information. Also, the trading decisions themselves are made public. Therefore, in all these scenarios, we have transparency.

Logic of Illegal Insider Trading

Essentially, the law punishes people who use restricted information leaving others at a disadvantage.

In this sense, if a company declares bankruptcy, and its CEO sells the stock afterwards, that’s alright. However, if a CEO sells shares before the company makes an unpopular announcement, it’s a likely candidate for an insider trading stocks lawsuit. The logic of the law goes against such a person because he used the yet non-public information to his own advantage, leaving the public at a measurable disadvantage.

Martha Stewart’s Case

Martha Stewart’s case is a good example of illegal insider trading.

In 2001, Martha Stewart was a famed American businesswoman and TV-personality. She had shares of a biotech company, ImClone, and sold them. In 2001, a biotech company ImClone announced that it failed to get its primary pharma product, Erbitux, approved by the US Food and Drug Authority. Its shares dropped 16% immediately after.

Martha Steward sold her shares of ImClone just a few days before the company’s dramatic announcement. By doing so, she saved some $45,000. That wasn't the end of the story though.

Legal authorities investigated the “timely manner” of this transaction and found that ImClone’s CEO Sam Waksal informed Martha Stewart about what was coming in return for gratitude on her behalf. Both were found guilty of insider trading. Sam Waksal received 87 months in prison and a $3 million fine. Martha Stewart was sentenced to 5 months in prison, a $195,000 fine, and the abrupt end as the CEO in her company.

Insider Trading and Olymp Trade

You may have noticed that the scenarios are about actual or potential stockholders of company shares. Also, these cases usually involve high-ranking people inside corporations. That means, if you were holding or planning to hold a big share in a big company, you’d theoretically be in the risk zone of insider trading. That’s not the case with Olymp Trade.

Trading on stocks on the Olymp Trade platform, you trade on their prices only. Therefore, unlike insider traders or real company shareholders, you don’t have to face the risks associated with having stock in a public company.

At the same time, opening an  Up or  Down trade with a stock you like in Forex, Fixed Time, or Stocks trading modes on the platform, you can make profits on the stock price trends in a manner that is potentially comparable to that of any insider.

There is plenty of analytical information and tools available to you on the Olymp Trade platform which can help make your trading simple and effective. You can use fundamental analysis of Insights, price direction forecasts in Trading Signals, use technical tools such as indicators and advisors, and expand your knowledge with a multitude of Forex trading tutorials in the Help Center.

Risk warning: The contents of this article do not constitute investment advice, and you bear sole responsibility for your trading activity and/or trading results.