Insider trading: why trading on secret information is banned

Insider trading is one of the most serious offences in the stock market. This guide explains what insider trading is, why it is banned and how the regulator acts against it.

Quick answer

Insider trading is buying or selling a company's shares using important secret information that is not yet public. Because this gives an unfair advantage over other investors, insider trading is illegal. SEBI polices it strictly to keep the market fair, so everyone trades on the same publicly available information.

Key takeaways

• Insider trading uses secret, price-sensitive information.
• It gives an unfair advantage over other investors.
• It is illegal and policed by SEBI.
• It undermines trust in the market.
• Penalties can be severe.

What is insider trading?

Insider trading is when someone buys or sells a company's shares based on important information that is not yet public. This secret information, if known to the market, would likely affect the share price.

For example, someone who knows about big results or a deal before it is announced could trade to profit, or avoid a loss, ahead of everyone else. Doing so is insider trading.

Why is it illegal?

Insider trading is illegal because it is unfair. It lets a few people with secret information gain at the expense of ordinary investors who only have public information to go on.

If insider trading were allowed, people would lose trust in the market, believing it is rigged in favour of insiders. That trust is essential for a healthy market, so the practice is banned.

Who can be an insider?

An insider is anyone who has access to secret, price-sensitive information about a company. This can include employees, directors, and others connected to the company who learn such information through their position.

It is not only trading yourself that is banned. Passing secret information to others so they can trade, sometimes called tipping, is also treated as insider trading.

How does SEBI act against it?

SEBI has rules and tools to detect and punish insider trading. It can investigate unusual trading, examine communications and take action against those found guilty.

Penalties can include heavy fines, returning wrongful gains and bans from the market. Serious cases can lead to further legal consequences.

What should investors know?

For ordinary investors, the key point is to trade only on public information. Acting on a secret tip, even one received casually, can cross into insider trading and carry real risk.

Understanding insider trading helps you stay on the right side of the rules. Any investment decision should be your own after proper research using public information.

Frequently Asked Questions