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What is insider trading?

If you have any involvement with the sale or purchase of stocks, you have likely come across the term insider trading before. Even people uninvolved with trading recognize it as a problematic issue.

But what exactly is insider trading, anyway? Why does it pose such a problem? And does it actually put the stock market at risk?

Examples of insider trading

The U.S. Securities and Exchange Commission takes a look at the definition of insider trading. In essence, insider trading involves the purchase or selling of stocks based on information the public does not have access to.

For example, say you work for a company and all employees recently learned it will soon file for bankruptcy. If you choose to sell your stocks immediately in anticipation of its worth plummeting, this is insider trading. The same counts if you catch wind of a financial boom in a company and invest in it before word gets out to the public.

Why is it a problem?

But why is this such an issue? Insider trading is often penalized with hefty fines and even jail time. You can end up with up to 20 years of jail time and a maximum criminal fine of $5 million. Needless to say, this is an enormous blow.

Insider trading gets taken so seriously because it does in fact have the potential to upset the entire market. How? Because it ruins the trust that investors have in the market’s integrity. If they believe insider trading dominates the market, they will stop investing. This can cause the entire market’s set-up to collapse, which is why such fierce protective measures are in place to this day.

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