Rumours in the Marketplace

We often receive calls from share trading, or share investing subscribers asking our opinion on certain stocks that they have heard are sure to increase in value, normally they have heard from a friend or acquaintance that there is something about to happen that will send the share price through the roof. Apart from the fact that we are only licensed to provide general advice and are therefore unable to offer an opinion on individual stocks, we are also unwilling to comment on information that may be classed as insider trading.

Disclosure

All information about a company that is listed on the ASX (Australian Securities Exchange) should be announced by the company and therefore made public so that everybody is aware at the same time. A seemingly harmless piece of market gossip may not seem to be of concern to most 'mum and dad' investors; however most public insider trading scandals usually seem to involve high-net worth individuals who either hold board positions and are privy to price-sensitive information.

However, the question of disclosure is relevant to the smaller trader, especially those who may find themselves in possession of any such gossip. The Australian Securities and Investments Commission (ASIC) enforces insider trading regulations, their aim is to ensure that everyone can buy, sell or hold their shares based basically on the same information. It does seem that compared to the amount of 'co-incidental' trading in stocks prior to announcements, insider prosecutions are few and far between.

Whilst it doesn't seem possible that ASIC can effectively control insider trading in the retail market there should always be a concern if the information received is from a family member who may work for, or be a consultant to, the company concerned. However, the rules also apply to far less direct forms of exposure. If you think you have confidential information - that you know is confidential and would reasonably be expected to be price sensitive - you should not trade on the basis of that information, even if you got it some other way the law still applies. In essence, this means that acting on information that appears to be well removed from its source - even overhearing it on a train - is still insider trading no matter how many degrees of separation.

Ramping

Apart from the remote chance that ASIC may be able to identify, and more importantly prove, insider trading at the retail level there are other risks involved with trading on such information. As we have mentioned many times before 'ramping' is something that you will come across time and time again. Ramping involves market manipulation by deliberately generating and spreading a false rumour that would increase market interest in a particular stock. This may be in the form of somebody spruiking a rumour on a website chat room, or spreading information somewhere like a church group, sports body or a parents group. Listening to these rumours and acting on them is not wise, the end result is that you are actually more likely to be a victim of these practices rather than the beneficiary.

With the amount of takeover activity in the marketplace at present there is a huge temptation to believe that the rumour you hear is true, that XYZ will be taken over because ABC had an offer made for it. Eventually the rumour may be true, after all, an attractive company with large cash reserves and a good P/E ratio will be considered a takeover target by many. But as with all things, timing may be the key. The chart below is AWC from May 2006, it shows a frantic 5 day period (yellow highlight) where a rumour of an impending offer swept the market. The subsequent 25% fall (also shows a Gap reversal) when the rumour was debunked would be a stark reminder that the old stockbroker adage of 'buy on the rumour, sell on the fact' should ring true with the retail investor. You may also be interested in reading the article on contrarian opinion.