It seems perfectly natural and innocuous that those with the most information would want to profit from it, and doing so isn’t illegal anywhere else. So why is it prohibited to make trades based on information not everyone has? What undesirable thing does this prevent?
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So as others have said, insider trading does do harm to people. Profittinh off inside information is generally considered unethical, and we DO make it illegal in a lot of other cases.
Cars for one. Almost all states have lemon laws, and generally, if I sell you a car without disclosing something thag I known is an issue, I will be liable.
Proper disclosures are also required in house sales, and even labellong on packages has standards and cannot be knowingly false.
BUT allowing all insider trading would actually be WORSE than what most people are saying. What we have now are markets where very few people have good inside information, but most people have relatively little secret information.
This means that the biggest problem is that someone loses when an insider trades.
But, if you make insider trading legal, we can imagine a situation where almost all traders are people with inside information. Luckily, there is A LOT of research and quite a few models that predict what this would look like, but here is the ELI5:
Imagine you and I are betting on coin flips. I get to flip a coin and observe the outcome. You do not get to see whether it is heads or tails.
Once the coin is flipped (and after I know the result), I will bet you that it is heads or tails.
Would you ever take the bet? OF COURSE NOT! It is not a fair bet. You will never win. So what happens?
We just don’t bet.
The same thing happens in stock markets when they are all insiders trading. No one actually trades, because chances are the other party knows more than you do. If you are not an insider, the best strategy is not to play.
This is fine if we are gambling on coinflips, but it is an issue for a company that is trying to raise money. If the insiders already had enough money, they would not need to sell stock publically. But allowing rampant insider trading means that you wont be able to sell your stock at all.
Insider trading pretty rampantly breaks down markets in a lot of different ways.
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