’orders quickly fill at the best available prices.
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Definitions of best execution are controversial because determining whether dealers fill orders atthe best available prices is difficult. It is especially difficult when willing traders do not displaytheir orders and quotes.Definitions of best execution are also controversial because price is only one dimension ofexecution quality. Traders value speed of execution as well as price. The relative importance ofspeed and price depends on order type. Market order traders are primarily concerned aboutspeed whereas limit order traders are most concerned about price. All traders, however, valueboth dimensions and accept reasonable tradeoffs between speed and price.Brokers and the dealers to whom they preference orders have created a standard set of orderhandling practices that they claim assures best execution if followed. You may disagree. Theprocedures vary by order type.In US equity markets, dealers claim that they provide best execution when they fill marketableorders at the national best bid or offer (NBBO)—the best bid or offer quoted by any other dealeror limit order trader. This standard applies only to marketable orders that are smaller than thetotal displayed quotation size at the best price. Best execution for larger marketable orders isharder to define because undisclosed size might also be available at the best price. To attractorder flow, some dealers guarantee to brokers that they will always fill orders at the BBO up to aspecified maximum size, regardless of the size displayed in the market.In some markets, small market orders often trade at better prices than the best quoted price. Insuch markets, brokers must obtain average rates of price improvement for small market orders toensure best execution. Dealers who fill their orders generally use complex algorithms to provideprice improvement given various market conditions. These algorithms often expose an order tothe market at an improved price. If anyone trades anywhere at that price, dealers then fill theorder at that price.The Primex Auction SystemThe Primex Auction System allows participants to expose their marketable orders to anelectronic crowd of traders who may offer improved prices. The Nasdaq Stock Market operatesthe system as a facility under an agreement between Nasdaq and Primex Trading.Several large financial services firms, which have very large dealing operations, own PrimexTrading. They include Bernard L. Madoff Investment Securities, Goldman Sachs, MerrillLynch, Morgan Stanley Dean Witter and Co., and Salomon Smith Barney.Source: www.primextrading.com
Best execution standards for standing limit orders are also difficult to define. Since standinglimit orders typically execute at their limit prices, brokerage clients are most concerned aboutwhether and when their orders execute. Best execution for orders that are not marketable uponsubmission therefore depends on whether and when they execute.In markets that match public orders to public orders, best execution standards for standing limitorders are especially difficult to define. Clients generally expect that their brokers will representtheir orders wherever they have the highest probability of executing. Brokers who internalizetheir agency orders or who preference them to dealers must ensure that they execute at least as
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soon as they would otherwise execute in the primary markets. Many dealers who accept limitorders have limit order price protection procedures to provide this standard of best execution.Best Execution of Limit Orders by Third Market Dealers in NYSE-listed StocksMany third market dealers who accept agency limit orders for NYSE-listed stocks use someversion of the following algorithm to provide best execution for limit buy orders. They usesimilar procedures for limit sell orders.If the limit order bids a better price than the dealer is bidding, the dealer will adjust his bid toreflect the limit order price and size. If the two prices are the same, but the limit order bids formore size than does the dealer, the dealer will increase his bid size to the order size.While the limit price matches the best bid in the market, the dealer will match any marketablesell orders that he receives with the limit buy order. If a trade occurs anywhere at a price belowthe limit order price, the dealer will fill the limit order for his own account at the limit price. Thedealer may fill all of the order, or just the size of the trade that occurred below the limit orderprice.When the limit order price is first equal to the best bid in the market, and the NYSE quote is alsoat the best bid, the dealer will record the size of the NYSE bid. If the NYSE bid is behind thebest bid, the dealer will record zero NYSE size. He then will count volume traded everywhere atthe limit price. When that total volume exceeds the recorded NYSE size, the dealer will executethe limit buy order for his own account.The dealer also may place a limit order into the NYSE specialist’s limit order book at the sameprice. If the NYSE order fills, he will fill his agency limit order. If he fills the agency orderfirst, he will immediately cancel the NYSE order. By placing the NYSE order, he ensures thathe will obtain no worse execution for the agency order than it would have received had it gone tothe NYSE. He can also query the SuperDot order routing system for the size ahead of the order.The fact that dealers pay for marketable orders suggests—but does not necessarily imply—thatthey could provide better execution services than they do. In particular, dealers may not beproviding as much price improvement for marketable orders as they might. They may also beextracting too much option value from standing limit orders that brokers often force them toaccept as a condition of receiving marketable orders. If brokers demanded more priceimprovement and better limit order executions, dealers would pay less for their preferenced orderflows.To fully understand how payments for order flow affect retail traders, we must consider morethan just that the payments exist. We also must consider how those payments are determined,and what effect those payments have on retail brokerage commissions. The next subsectiondescribes the economic factors that determine payments for order flow, and how they affectbrokerage commissions.25.2 The Economics of Best ExecutionWe start our discussion with a well-known property of all competitive markets. In perfectlycompetitive markets, nobody earns profits in excess of a fair rate of return on their dedicatedresources. Perfectly competitive markets arise when suppliers with identical cost functions can
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Chapter 26Competition within and among MarketsIn the last few years, many exchanges, brokers, electronic communications networks (ECNs),and dealers have created innovative trading systems to provide traders with better services atlower costs. The competition among these market centers is significantly changing how allmarkets operate, and the pace of change is accelerating.The competition among market centers has some worrisome consequences, however. Theproliferation of market centers is fragmenting the markets. Buyers and sellers often are indifferent places so that they may have trouble finding each other. Their transaction coststherefore may be higher than they would be if all traders traded in the same place. The benefitsof competition among market centers may be offset by the increased costs it creates for traderswho are searching for the best price.Where Is the Market for AOL?AOL Time Warner common stock trades in each of the following market centers:
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The New York Stock Exchange, its primary listing market.All US regional exchanges: The Boston, Chicago, Cincinnati, Pacific, and PhiladelphiaExchanges.Most ECNs and alternative trading systems (ATSs). The most important of these are Island,Instinet, REDIBook, Archipelago, Bloomberg Tradebook, BRUT, and POSIT.The third market and Nasdaq. Bernard Madoff Investment Securities and Knight CapitalMarkets are the largest dealers in these markets.The upstairs block trading market.Some large foreign stock exchanges.
The risk in AOL common stock also trades in the following derivative contract markets:
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US options exchanges all trade AOL stock options contracts cleared by the Options ClearingCorporation. These include the Chicago Board Options Exchange, the American StockExchange, the Pacific Exchange, the Philadelphia Stock Exchange, and the InternationalSecurities Exchange.Futures contracts on AOL common stock shares trade at several exchanges.Many large investment banks will write individually tailored synthetic derivatives contractsin AOL for their clients.
A market in which people can trade essentially the same thing in different market centers is afragmented market. A market in which all traders trade in the same market center is aconsolidated market.Regulators and practitioners wonder whether markets should be consolidated or fragmented.Regulations can produce either alternative. Most futures markets are fully consolidated, as aresome national stock markets.
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The issue is quite complicated. The competition among traders to obtain the best price worksbest in consolidated markets. The competition among market centers to provide low costservices to traders, however, implies fragmented markets. The two competitions therefore areinconsistent with each other. Any reasonable attempts to address competitive issues mustconsider why market fragmentation occurs, and what are the benefits and costs of marketdiversity.Slogans Don’t HelpAll languages promote wisdom with slogans. Slogans, however, will not resolve debates onmarket structure. For example, “United We Stand, Divided We Fall” suggests that consolidatedmarkets are good, but “Strength through Diversity” suggests that fragmented markets are good.When applied to market structure, these two slogans promote the two different competitions thattake place in the trading industry. The first slogan promotes the competition of traders to findthe best price while the second promotes the competition among market centers to provide thebest services.In this chapter, we consider the economic forces that cause markets to consolidate and tofragment. Our discussion starts with a short description of how technology has changed tradingmarkets. This part presents the technological context of the main issues. The economic analysisstarts with a discussion of why markets consolidate. We then consider why markets fragment,and how fragmented markets coalesce into segmented markets. Finally, we address the publicpolicy problems related to externalities among market segments.26.1 Trading Systems and TechnologyNew trading systems have proliferated largely due to advances in communications andcomputing technologies. New communications technologies have given traders instantaneouspresence in markets that they formerly could not attend. Traders no longer need to be on anexchange floor to know what is happening there or to trade effectively. Instantaneous marketdata reporting systems and order routing systems now allow traders anywhere in the world to seeand act upon opportunities wherever they occur.
From Dispatch Messenger to ECNIn the beginning, markets reported some trade prices—and almost no quotations—by dispatchmessengers. They usually traveled by horseback and ship. Later they reported prices by carrierpigeon, semaphore, telegraph, telex, and telephone. Now most organized markets continuouslyreport all trade prices and all quotations as they occur via dedicated communications systems runby computers. Information that once moved at equine speed now moves at the speed of light.Likewise, traders once made all trading decisions themselves and brokers once arranged alltrades manually. Now computers commonly make and implement trading decisions whilededicated exchange, ECN, broker, and dealer trading systems arrange trades automatically.New computing technologies have allowed market centers to organize sophisticated algorithmbased order-matching systems that would be impossible to implement by hand. These systems
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provide traders with complex order management tools that permit traders to more effectivelysolve their trading problems. Examples of such features include systems that
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display orders only to traders who commit to filling them,ensure that a trader buys and sells equal dollar values,ensure an order that is part of a larger strategy will fill only if all orders in the strategy fill,allow traders to submit orders with limit prices indexed to market conditions, andsubstitute orders in one instrument for orders in another instrument based on marketconditions.
Trading systems that incorporate these features use complex rules to treat all traders fairlysubject to various constraints. They could not be implemented without the assistance of acomputer. New computing technologies therefore have allowed markets to develop newapplications that formerly would have been economically infeasible.The OM SAXESS Trading SystemOM Gruppen of Stockholm sells and operates exchange trading systems. Their SAXESS systemallows traders to submit various types of contingency orders: combination orders, linked orders,stop loss orders, block orders, and balance orders. The algorithms necessary to provide theseservices are quite complex because the execution of some orders is contingent on the executionof other orders.Source: http://www.omgroup.com/
Even when clerks can effectively operate a trading system by hand, they are not as cost effectiveas are computers. New computing technologies therefore have allowed market centers to lowerthe costs of existing services in addition to providing new services.26.1.1 A Very Short History of Fragmentation and ConsolidationIn the beginning, most trading occurred on the trading floors of regional exchanges. Professionaltraders wanted to belong to these exchanges because only by being on these floors could theylearn about market conditions and access trading opportunities. Nonmembers traded throughmember-brokers because that was the only way they could trade in these markets. Although nosingle market structure can simultaneously best serve the needs of all traders, most traders tradedat exchanges because everyone traded there.
Trading in many instruments fragmented across regional exchanges because impatient traderswould not send their orders to distant exchanges. These traders incurred high transaction costs tocompensate dealers who moved liquidity through time and arbitragers who moved liquidity frommarket to market. Wide arbitrage spreads reflected the high costs of obtaining information andacting upon it across large distances.When new communications technologies reduced the costs of transmitting market informationand orders, regional exchanges consolidated to form large international markets. Wherepermitted, many alternative trading systems operate on the periphery of these markets. Thesesystems provide special services to traders whose needs vary substantially. Arbitrageurs ensurethat prices in all systems reflect market conditions throughout the world.
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Chapter 27Floor versus Automated Trading SystemsAdvances in communications and computing technologies now allow exchanges to completelyautomate their trading systems. Many exchanges have done so and many brokers, ECNs, anddealers have created automated trading systems.Despite these developments, many of the most liquid exchanges in the world still employ floorbased trading systems. The New York Stock Exchange, the Chicago Board of Trade, theChicago Mercantile Exchange, the New York Mercantile Exchange, and almost all US optionsexchanges primarily use floor-based trading systems. Although traders on their floors now relyextensively on electronic systems to route orders and report confirmations, they still arrangetrades essentially as they did when these markets first started.If the floor-based market structures at these exchanges encourage traders to offer liquidity,eliminating their floors would be foolish. However, if other reasons account for the liquidity inthese markets, switching to electronic trading may be desirable.When floor-based trading systems and electronic trading systems compete head-to-head witheach other, the results have been mixed. During the 1980’s, the London Stock Exchange was themost important market for large French stocks. In 1989, the Paris Bourse introduced anautomated electronic trading system. Since then, much of the trading in French stocks migratedfrom London to Paris. More recently, the electronic German DTB futures exchange wrestedtrading in German T-bond futures from the floor-based London International Financial FuturesExchange (LIFFE). Neither example, however, provides definitive evidence for or against floorbased trading because other events have also influenced the outcomes. The market share of theParis Bourse grew following the 1994 repeal of a French transaction stamp tax which tradersformerly avoided by trading in London. Likewise, the German T-bond futures contract movedfrom LIFFE to DTB in response to a coordinated effort by German banks to repatriate theirmarket.In contrast, brokers, dealers, exchanges, and ECNs have created many automated systems fortrading NYSE stocks and US equity options. Some of these systems have been notablysuccessful. Optimark—discussed in the previous chapter—failed spectacularly. The ArizonaStock Exchange proved to be a disappointment to people who believe that markets would benefitfrom electronic call markets. Instinet, Archipelago, and Island ECN have not taken substantialmarket share from the New York Stock Exchange despite their tremendous success competingagainst the electronic Nasdaq Stock Market. The electronic International Securities Exchangeobtained a 16 percent share of US equity option trading in the issues it trades, within 18 monthsof its 2000 launch. However, it has not yet displaced the traditional floor-based options markets.The most successful electronic competitors to the NYSE have been third market dealers, likeBernard L. Madoff Investment Securities and Knight Capital Markets. Their automated tradingsystems provide very quick service primarily to retail traders represented by discount brokers.Floor-based oral auctions and automated rule-based auctions are very similar. Both are orderdriven markets that match buy orders to sell orders using very similar rules. Their primarydifference lies in the technologies they use to arrange these matches. Traders in oral auctions
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arrange trades by personally exchanging information among themselves whereas in automatedmarkets, computers arrange the trades.Since the two market structures are so similar, exchange officials, regulators, and tradersnaturally consider which is best. There is no simple answer. Both structures have strengths andweaknesses.The Bangladeshi Stock Exchange and the New York Stock ExchangeIn 1999, the Bangladeshi Stock Exchange replaced its trading floor with an automated tradingsystem. At the same time, the New York Stock Exchange considered where to build a newtrading floor.The continued commitment of the New York Stock Exchange to its trading floor may be its mostimportant decision at the turn of the millennium. The members and officers of the Exchange arefully aware of its significance. They believe that the tremendous success of the NYSE is due inlarge part to its floor-based market structure. They also know that they may lose much, if not all,of their franchise if they are wrong.In this chapter, we consider the arguments for and against these two trading structures. Ourdiscussion examines how they differ in fairness, convenience, capacity, speed, efficiency, andcost.27.1 FairnessTwo concepts of market fairness concern traders. Traders want their markets to operate fairly,and they want fair access to those markets. In operationally fair markets, trading rules areuniformly applied, and no cheating occurs. In fair access markets, all traders have an equalchance to take advantage of any opportunities that arise.
27.1.1 Operational FairnessMany traders believe that automated trading systems are the fairest of all market structures.Automated systems do only what they are programmed to do. They implement their tradingrules exactly and without exception. They expose orders only as instructed, and only to thosetraders to whom the system permits orders to be exposed.
In contrast, fairness in oral auctions depends on the skill and honesty of the traders who arrangethe trades. Traders must be highly skilled to follow the trading rules faultlessly when the marketis active, and when prices are moving quickly. They must honestly follow those rules even whendoing so may cause them to lose an advantage.Although most oral auctions are quite fair, all oral auction markets have suffered from welldocumented trading scandals. These scandals usually involve front running, inappropriate orderexposure, fraudulent trade assignment, or prearranged trading by dishonest brokers.Although these problems can also arise in automated markets, they cannot take place within theirautomated trading systems. Instead, dishonest brokers must conduct their frauds on the side.Markets prevent these frauds by having officials supervise trading, by investigating suspicioustrading practices reported by honest traders, and by maintaining—and reviewing—reliable audit
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trails. An audit trail records the submission and disposition of every order. Good audit trailsinclude detailed information about everything that happens to each order. Regulators use audittrails to determine whether traders have violated trading rules. An accurate audit trail helps keepbrokers honest.Floor-based markets have extensive rules that govern how traders process orders and recordtrades. Markets design these rules to make the audit trail complete, reliable, and accurate. Theserules require traders to time-stamp their orders when they receive them and when they fill them,to record trades sequentially, and to report trades immediately.Automated trading systems easily produce complete and flawless audit trails of all activity thattakes place within their systems. Many traders and regulators especially like these systems forthis reason.What Would You Think?Eli needed to roll a 10-contract short futures position in the Dow Jones Industrial Average Indexfutures from the June to September contracts. Via the Internet, he submitted a spread order tobuy 10 June contracts and sell 10 September contracts with a limit of 75, premium to the sellside. The DJIA index futures contracts trade in a pit on the floor of the Chicago Board of Trade.About a half hour later, Eli queried his broker’s Internet site and discovered that he bought theJune contracts for 11,060 and sold the September contracts at 11,130. The 70-point differencewas less than the 75 points that Eli specified.Since the nominal size of the DJIA contract is 10 times the Dow index, each point is worth 10dollars per contract. For ten contracts, the five-point difference between the reported spread andthe limit represents 500 dollars.Eli naturally called his broker and inquired about the discrepancy. Since the broker did notfollow his instructions, Eli could have refused to accept the trade, or he could have demandedthat his broker make up the difference. The sales broker who answered the phone asked him tohold the line while she called the floor to inquire about the problem. One minute later, shereported that the floor incorrectly reported the trade price of the sale. She said that theSeptember contract actually sold for 11,137 so that the spread trade occurred at 77 rather than 70.Eli was pleased with the result.What really happened? Consider the following four alternatives:A. Somebody incorrectly reported the trade, most probably due to a typo or a transcription error.Had Eli not reported the discrepancy, someone would have noted it later, and the brokerwould have properly adjusted Eli’s account.B. Somebody incorrectly reported the trade. Had Eli not reported the discrepancy, the brokermight have pocketed the difference.C. The floor trader executed the trade incorrectly by mistake. The trader or Eli’s broker madeup the difference and added two points to keep Eli happy.D. The floor trader intentionally executed the trade incorrectly and hoped that Eli would notnotice the mistake. The trader or broker made up the difference and added two points to keepEli happy.
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Chapter 28Bubbles, Crashes, and Circuit BreakersBubbles and crashes occur when prices greatly differ from fundamental values. The wealth thatthese events create, destroy, and redistribute is often enormous. Bubbles and crashes thus arequite scary when prices change quickly.Extreme volatility concerns many people:
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Traders pay close attention to it because large unexpected price changes expose them totremendous risks and opportunities.
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Clearinghouses worry about extreme volatility because traders who experience large lossesmay be unable to settle their trades or contracts. Clearinghouses and their members mustbear the costs of resulting settlement failures.
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Exchanges and brokers plan for extreme volatility because extreme price changes usuallygenerate—or are generated by—huge volumes that can overwhelm their trading systems andcause them to fail. Large sustained price drops especially concern them because tradingvolumes usually shrink substantially and remain low for a long time afterwards.
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Microeconomists fret over extreme volatility because very large price changes often appearinconsistent with rational pricing and informative prices. They wonder whether excess pricevolatility causes people to make poor decisions about the use of economic resources.
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Macroeconomists fear that the wealth effects associated with large, broad-based changes inmarket values may adversely affect the investment and consumption spending decisions thatcompanies and individuals make. Poor spending decisions can cause unsustainable boomsand protracted contractions in economic activity.
These concerns explain why market regulators regularly examine trading practices and tradingrules that might induce or attenuate extreme volatility. Some policies that they consider cancreate markets that are more resilient. Other policies have little value, and many policies canharm the markets. Regulators therefore must carefully analyze how market structure affectsvolatility before adopting new policies.In this chapter, we consider what causes extreme volatility, and how regulations might make itless likely or less dangerous. Not surprisingly, analysts generally understand the causes ofextreme volatility better after the fact than beforehand. Volatility episodes rarely have commoncauses. They do, however, tend to fit a common pattern. Traders who can recognize conditionsthat may lead to extreme volatility can take positions that are highly profitable. Regulators whocan recognize these conditions can occasionally adopt policies to reduce the harmful aspects ofextreme volatility.We start our discussion by distinguishing among the types and causes of extreme volatility andthen illustrate these points by considering several examples of bubbles and crashes. We nextexamine how changes in market structure can affect extreme volatility. Finally, we brieflyconsider how politics affect regulatory policies taken in response to extreme volatility.
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28.1 Bubbles and CrashesBubbles occur when prices rise to levels that are substantially above fundamental values.(Fundamental values, of course, are not common knowledge. If they were, crashes and bubbleswould not occur.) Some bubbles occur very quickly. Others occur over long periods. Manybubbles end with a crash. Traders say that such bubbles pop.
Crashes occur when prices fall very quickly. Crashes often follow bubbles, but they also occurin other circumstances. Crashes sometimes are called market breaks because the price pathbreaks when prices fall very quickly. They also are called market meltdowns when they overloadthe order handling capacity of a market.Bubbles and crashes may affect an individual trading instrument or many instruments at once.Those that simultaneously affect many instruments are broad-based events or market-wideevents. Very large price changes most commonly affect only an individual instrument. Broadbased bubbles and crashes are quite rare.28.1.1 Typical Bubble and Crash DynamicsBubbles start when buyers become overly optimistic about fundamental values. The potential ofnew technologies and the potential growth of new markets can greatly excite some traders.Unfortunately, many of these traders cannot recognize when prices already reflect informationabout these potentialities. They also may not adequately appreciate the risks associated withholding the securities that interest them. If enough of these enthusiastic traders try to buy at thesame time, they may push prices up substantially.
The resulting price increases may encourage momentum traders to buy on the hope that pastgains will continue. Some momentum traders may buy because they hope to obtain the profitsthat their neighbors and friends have already earned. If enough traders follow them, they willrealize their hopes. The last buyers, however, will lose badly.Order anticipators may also buy in anticipation of new uninformed buyers. They will profit ifthey can get out before prices fall.The combined trading of these traders can cause a bubble in which prices exceed fundamentalvalues. Momentum traders and order anticipators, in particular, tend to accelerate price changes.Prices also accelerate when early buyers grow more confident as their wealth increases, andwhen early sellers repurchase their positions to stop their losses.The Price AcceleratorIncreases in prices transfer wealth from pessimistic traders who have short positions to optimistictraders who have long positions. These transfers can cause accelerate price changes.When prices rise, optimistic traders get wealthier. The most optimistic traders may buy more. Ifthey do, they may cause prices to rise further.When prices rise, pessimistic traders lose. The losses of the most pessimistic traders may forcethem to buy back short positions to cover margin calls. Their buying may cause prices to risefurther.
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In both cases, the sellers will be traders who do not have such strong opinions. Mild pessimistswill sell because the increase in market price makes short positions more attractive. Mildoptimists will sell because the increase in market price makes their long positions less attractive.Source: “The Canonical Bubble,” manuscript by Jack Treynor.
Value traders and arbitrageurs may recognize that prices exceed values, but they may be unableor unwilling to sell in sufficient volume to prevent the bubble from forming. These traders maybe unable to sell as much as they want to sell if they do not have large positions to sell, if they donot have enough capital to carry large short positions, or if they cannot easily sell short. Theymay be unwilling to sell if they suspect that uninformed traders will continue to push prices up,or if they lack confidence in their abilities to estimate values well.You Believe You Are Right, But …(Confidence Is Everything)Even when value traders believe that prices greatly differ from fundamental values, they maylack the confidence to trade on their opinions. To trade against the majority opinion requiresgreat courage. Since markets generally aggregate information from diverse sources extremelywell, value traders must always wonder why they believe that they understand values better thaneveryone else does. Value traders will not trade unless they are confident that they are right,even after considering that the majority of traders think otherwise.Value trading is especially difficult when unresolved uncertainties make it impossible for anyoneto estimate values well. In which case, value traders will not trade until price is far from theirestimates of value. This observation explains why bubbles often form in the stock prices ofcompanies that hope to profit from highly promising, but unproven technologies.Eventually prices rise to a level that causes sellers to start trading aggressively. The sellers maybe long-term holders, early buyers who want to realize their gains, contrarians, value traders, orarbitrageurs. Once their selling causes prices to fall, momentum buyers lose their interest.Overly optimistic buyers lose their confidence and sellers become more confident. Late buyersespecially worry about their positions and often start selling to stop their losses. Those traderswho financed their positions on margin may have to sell their positions to satisfy margin callsfrom their brokers. Other long holders who have placed stop loss orders also will start to sell.Order anticipators may anticipate these margin calls and these stop orders and sell before them.A crash occurs when the combined effect of all their selling causes prices to quickly fall.You Know You Are Right, But …(Timing Is Everything)Consider the trade timing decisions that value traders must make when they believe that pricesare too high:If they initially have long positions, and they sell them too soon, they will lose the opportunity tosell at higher prices as uninformed traders cause prices to continue to rise.If they initially have no positions, and they sell short too soon, they initially will lose on theirshort positions. If they cannot finance their losses, their brokers will force them to buy to covertheir losses, and they will lose the opportunity to ultimately profit when prices fall.©2002 Oxford University Press
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Chapter 29Insider TradingTraders engage in insider trading when they base their trades on material information about thevalue of an instrument that is not publicly available. Most insider trading involves privateinformation that corporate managers know about the future prospects of their companies. Insidertrading also may involve information that