I tried researching (I’ve been watching Suits and I’m at the part when Stutter is accused of insider trading) and I still don’t understand what they mean by “making trades based on nonpublic information”. So please explain like I’m five what this really means.
In: Economics
Investing in the stock market is supposedly open to all and fair. Investors can look up any company they wish, look at their data, their earnings, their plans for the future, their debts, etc and make a decision based on various factors on whether they want to invest in the company or not. Big news that may affect the price of the stock are usually announced when the stock market is closed, and they’re announced publicly so that everyone has a fair chance to hear the news at the same time and decide if they want to act on those news. That’s events like plans for expansion, plans for acquisition, changing CEOs, announcing a new product or some breakthrough in the field, etc.
Insider trading is when company insiders tell their friends what the upcoming news are before they’re announced to the public so that they can take advantage. This usually allows them to open a position much cheaper than everyone else and get much better returns. They may also be warned of a potential downturn and protect their investments in time. This is not only unfair but also illegal. Unfortunately it’s very hard to catch and prove.
For example let’s say I’m a company insider in company X, with the stock being worth 20$. I tell a friend that we’re announcing earnings next month and they’re much better than previous quarters so my friend buys in. On the next day after the announcement the stock jumps 15% and most investors are lucky if they get to catch 8-9% of that. Next I tell my friend that the company will issue more shares, which generally lowers the price of shares. My friend can then sell his shares and even open a position that will benefit from the share price dropping. The next day it’s announced and the price drops 20%. For most investors holding the stock this means a 20% drop in the value of their investment but not for the guy who had insider information, he just gets richer again.
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