Sunday, October 25, 2009

Why Miron's Theory On Insider Trading Fails

Harvard's Jeffrey Miron in a defense of insider trading has written:
In a world with no ban, small investors might fear to trade individual stocks and would face a greater incentive to diversify; that is also a good thing.
This is a curious argument, since if insider trading were legal, markets would adjust quicker to an accurate market situation. A small investor may not be privy to insider board room secrets, but he certainly is privy, as is everyone else, to price action and volume action in a stock. Thus, when inside trading is legal, there is more information for the individual than during a period of no insider trading, i.e. it is easier for him to trade successfully. If a takeover is about to occur, and insiders are free to trade on this information, then the stock price will start climbing higher on heavy volume. This is important information for all investors, including small investors.

Perhaps, Miron views technical analysis of stock movements as voodoo forecasting, and indeed some technical analytic theory is voodoo theory. However, technical analysis as a science that is deduced from human action can provide extremely accurate price signals and volume signals as to what is occurring in a stock. Insider trading happens to be one of the easiest trends to spot via technical analysis. Legalizing insider trading would add to the accuracy of these signals.

Bottom line: Insider trading is not only good for markets in general because it allows the markets to adjust to the best available information about a company, but such adjustment, in a way, actually puts the small investor in the boardroom by his ability to observe stock price activity that now includes the activity of insiders.

Legalizing insider trading would provide more information to small investors, and make it more likely they would be willing to trade in individual stocks.

1 comment:

  1. Good point. I also thought the column was a very good argument for legalizing insider trading, especially the argument that someone who doesn't sell their stock because of insider information cannot be accounted for even though it is still insider trading. This law is just another example of our government turning otherwise productive citizens into criminals.