Insider trading occurs when a person takes advantage of the private, material information they possess about a company or stock to buy/sell the stock.
The Long Explanation
Insider trading is considered by regulatory agencies as one of the seven deadly sins of trading. In the United States, this sin – along with others like it – are adjudicated by the Securities and Exchange Commission (SEC).
The SEC oversees traders’ affairs and determines whether insider trading has occurred. According to the SEC, insider trading is “the buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security.”
To strip away the legal jargon, insider trading is said to have occurred when a trader buys or sells a stock by leveraging their knowledge of private, undisclosed information which can influence the price of the said stock.
This is considered illegal trading activity as it gives the buyer unfair advantage over other market players due to their privileged access, while also making the market even more prone to manipulation.
For instance, acting on a yet-to-be-public information, such as an acquisition or an indictment is considered insider trading as any of that information will affect a stock’s valuation (whether that’s positively or negatively).
There are extraordinary circumstances, however, when insider trading may be considered legal. A CEO of a company buying up additional shares in the company and discloses the same to the SEC; a board member purchases more shares and discloses it to the SEC; an employee exercises his/her stock options.
