Module 2: Investment Basics | Blog 2-4: Sources of Information by David S. Krause

In Lessons 2-4 and 2-5, you learned about the various sources of public information regarding the financial markets and individual companies. It is amazing the amount of information that is available online today – some of which is outstanding and some of which is worthless. What we didn’t discuss was the infamous ‘stock tip.’


Mad Money’s Jim Cramer (CNBC)

I believe everyone has received stock tips over time from family and friends – and every day we hear about some hot trading tips from the ‘experts’ on the TV financial networks.

Well, what exactly is a stock tip? It is loosely defined as a confidential, advance notice, or ‘legal’ piece of information on the future performance of a particular company’s stock that is intended for trading purposes.

Trading on material, inside information is not generally allowed in the United States. Insider trading is legal when corporate insiders—officers, directors, employees and large shareholders – buy and sell stock in their own companies. However, before corporate insiders can trade in their own securities, they must report their trades in advance to the SEC. Many investors and traders use this publicly disclosed information (which is available in EDGAR) to identify companies with good investment potential. The idea is that if insiders are buying their firm’s stock, they must know more about their company than everyone else, so therefore it must be a good idea to buy the stock. source money.cnn 2.4 and 2.5

Raj Rajaratnam being arrested on illegal insider trading in 2009 (source: CNN)

Many academics believe that in any market, stock tips are a really stupid idea. They argue that if someone could offer consistently profitable tips, why wouldn’t they be discretely trading on the knowledge to become super-rich? What share it with anyone else?

It is also hard to imagine many examples of how a stock tip could be legitimate or even legal (and not a violation of insider trading laws)!

Have you ever received a stock tip – and acted on it without conducting any research? I hope not. However, I do think that tips can be useful as a prompt to research new investment ideas or to help confirm your own opinion.

A word to the wise – be careful about acting on non-public, material information – you too could be photographed in a perp walk if you violate insider trading laws.


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