Insider trading is buying or selling a company’s stock when you have important inside information about the company that has not been made public. We tend to think of insider trading as being illegal, but that is an oversimplification. The top executives of a company almost always have inside information. If insider trading were illegal, then these executives could never trade their own stock. In the U.S., insiders are allowed to create prearranged trading plans, called 10b5-1 plans, for trading stock. The idea is that the executives can set out a plan to commit to trading stock at particular prices or at particular times. This way, the stock trades will happen automatically when the time comes, and the executive is protected from accusations of insider trading. Insiders beat the average But the insiders still seem to outperform other traders significantly. Business Week reported that “Alan D. Jagolinzer, an assistant professor at Stanford University Graduate School of Business...

In an earlier post , I explained that stock trading costs consist of the visible commissions and the less visible costs due to stock spreads . In the case of commissions, it is obvious who gets the money – the brokerage. In the case of stock spreads, it is less obvious where the money goes. If traders lose money due to spreads, who gets this money? You could imagine a stock trading system where potential buyers and sellers each submit a price and a number of shares, and a computer tries to match them up. This sort of system might work well for a very liquid stock that trades millions of shares each day, but it wouldn’t work as well for thinly-traded stocks. Suppose that you are looking to sell 100 shares of little known XYZ stock, and for three days running there haven’t been any reasonable bids to buy the stock. You would be quite unhappy. To make the system run more smoothly, each stock has one or more market makers whose job is to create a market in that stock. Market ma...

As I mentioned in my last post on the cost of trading stocks, I pay a $10 commission for each stock trade. In most years I make between 5 and 20 trades. If I average one trade per month for 25 years, the commissions will add up to $3000 (ignoring inflation). This is low enough that it won’t have a serious impact on my returns. My strategy for buying stocks is to guess at the future prospects of the business, determine a fair price for the stock, and compare this to the current stock price. If I buy a stock one day believing that the business will be successful, it is unlikely that something significant will happen in the first week or month that changes everything. This is why I tend to trade infrequently. What happens if you trade more frequently than this? Suppose that day-trader Dave is playing with $10,000 and makes 2 trades a day, 5 days a week, for 50 weeks a year. (Even day traders need 2 weeks off, don’t they?) The commissions add up to $5000 per year. So, Dave needs to mak...