Insider Trading vs High-Frequency Trading
John Kay writes about an old Rothschild legend that illustrates an important insight: we put people in jail if they get an advantage in the market by talking to insiders, but we let them spend hundreds of millions of dollars tunneling cables through mountains so they can trade a few milliseconds faster. In both cases someone profits from knowing the news before anyone else. So what’s the difference?
He ends the article by asking “Why should it be unacceptable to gain advantage from knowledge of the outcome of the battle but acceptable to gain advantage by getting faster to London with that news?” I think he knows as well as us that there is a difference. We punish insiders because the incentives of fully legalized insider trading would harm the markets a lot more than anything that’s legal now. Even if the enforcement goes too far that can still be a good thing since it deters market manipulation.
On the other side, insider trading that doesn’t involve market manipulation could be a good thing. If someone knows of bad news that is about to come out and starts selling large quantities of a company’s stock, that will drive the price down earlier. This saves uninformed buyers from over-paying for a stock that is about to crash. In this case the insider makes a profit but also performs a public service. That’s just the invisible hand of the market – the same standard we expect from any corporation.
This probably can’t be separated from the less beneficial form of insider trading. Similarly, high-frequency trading might get the news out sooner but it can also be used to simply run slower traders in circles, and it should probably be taxed to lessen the advantage. There is a public benefit from committed long-term investors working with transparent prices in a market where they bear full responsibility for their mistakes. Anything else should be watched very closely.