Insider Trading is a Good Thing

Boris Reitman
Sep 13, 2018 · 3 min read

As I was learning about the stock market, I understood this key point: the stock market is a secondary market. Before that, I thought that derivatives such as options and futures are secondary markets. Actually, those are tertiary markets relative to the original corporation issuing its stock.

A corporation that is issuing the stock is distributing its ownership among investors. No one is subsequently forcing these investors to trade certificates of ownership among themselves on a secondary market (the stock market). If they choose to do it, they can do so, but they must carry any risk on their own shoulders.

What are those trading risks? The original purpose of the stock, is to exchange investment for ownership, with the stock holders hoping that the company is going to continue producing value, and hopefully produce it more efficiently with time. Good examples are Google and Amazon, that kept innovating and innovating, and scaling up. So, if one chooses to trade his ownership of stock, or buy more into ownership based on some insider or public information, then he must judge if this information has any import. For instance, if one has learned, as much as 2-years before any other man, that Apple is making a watch, he would have to judge if it is going to be of significant value as a product. He would have to sink investment capital into Apple and hold-on for several years. Well, time has showed that the product is only a small increase in value, and probably wasn’t worth that investment.

The purpose of stocks is not for speculators to generate a daily revenue. The purpose is for long term investment into companies, hoping that these companies increase production value. All traders are actually arbitrageurs in a general sense: they remove inefficiencies in that long-term investment plan. They cause bad allocation of capital to be redirected into the right companies.

Besides becoming a stock holder, there are other ways to patronize a company. For instance, you could become its employee, trading your time for money. In this case, you are betting that it would profit enough to pay you. But, unlike with stock ownership, you can’t resell this contract — you have to be the one showing up at work. This de-facto standard could change, giving way to a secondary market for subcontracting your work. And, I think it is a way of the future, because that will bring more efficiency to the allocation of, this time, human resources.

In an ideal world, there should be no price fluctuations in a stock’s price merely because people are buying or selling it. It should only change based on results of company’s production. Those who are trading based on some insider information, are betting that it is more than just talk. Furthermore, those who are responding merely to price fluctuations, using things like algorithmic trading, swing trading, arbitrage, and other statistical techniques, are merely stabilizing the price. They are wave-breaks, that cause the price to stabilize as ocean water in a bay.

But, the world is not ideal, because people make honest mistakes. Not all corporate ventures succeed, and some succeed more than others. Traders uncover those mistakes, by either encouraging or discouraging some ventures. They vote with their money. That is risky, and their bravery deserves applause. And the biggest risk is taken up by those who are first to act on some insider information. Instead of condemning insider traders, we should applaud them.

References:

Harry Binswanger, “Insider Trading Is A Right: Don’t Shackle The Knowledge-Seekers”: https://www.forbes.com/sites/harrybinswanger/2013/08/05/insider-trading-is-a-right-dont-shackle-the-knowledge-seekers/#5a32b9045726

Yaron Brook, “Investing: An Objective Approach”:
https://estore.aynrand.org/p/133/investing-an-objective-approach-mp3-download

Check out my Capitalism Conversations series on YouTube: https://www.youtube.com/watch?v=x8Z_JadFMNI&list=PLENU2liCuAwyyrWZBfZGOv0od0BQ-afse

If you want to do an online interview with me, contact me at borisreitman.com.

Boris Reitman

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Speaking about ideas that matter, on an Objectivist foundation.

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