Stock market trading strategies and analysis

Stock Market Trading/Corporate Finance

Insider trading

Insider trading involves the trading of public company's stock or other securities such as stock options or bonds with people who can get access to non-public information regarding that company. However, there are some countries where insider trading based on insider information is considered illegal. Research shows that purchase portfolio normally earns abnormal returns for over 50 points every month. A quarter of these abnormal returns accumulate within the first five days after the first transaction while a half accumulates in the first month. The sale portfolio normally earns abnormal returns. In addition, studies show that abnormal returns in small firms do not differ significantly from those that are in large firms. At the same time, top executives do not earn higher abnormal returns compared to other insiders. Therefore we can say that studies on insider trading generally show that insiders make positive abnormal trading profits. These studies also show that outsiders can earn profits through mimicking the trade of these insiders after there is a public release of information regarding insider transactions (Jeng, Metrick, Zeckhauser, 1999).

According to research, insider trading forms semi-strong form market efficiency. In this form of market efficiency share prices normally adjust to the new information that is publicly available very rapidly and is usually not biased in such a way that there are no excess returns that can be earned through trading on that information. This market efficiency also implies that neither technical analysis nor fundamental analysis techniques will be able to produce excess returns reliably. However, there is still some evidence of pre-event day trading that is observed in research. Insiders and investors that are acting on information before announcement are shown to earn above normal profits. Evidence shows that insiders do not sell high, outsiders buy early, and low and hence, they are able to realize profits from this expectation.

The pecking order theory

This is a term in corporate finance, which postulates that the cost of financing increases with asymmetric information. This is an approach used in defining a company's capital structure as well as how the organization goes about making its financial decisions. Financing normally comes from three sources which are; internal funds, new equity and debt. Companies normally priorities their financing sources first they prefer internal financing, then debt and the last option they take is raising equity. This theory holds that businesses adhere to the hierarchy of the sources of financing and they thus prefer internal financing if it is available and they prefer debt to equity if external financing is a requirement. Therefore, the form of debit a n organization goes for can be a sign of the need for external finance.

If the amount of dividends paid by a firm declines then the amount of debt financing that a firm is using should also go down. The reason why the dividend policy so important to the pecking order theory is the fact that the propensity firms when it comes to paying dividends is that most of the firms normally follow the pecking order theory. This means that they go hand in hand and that the dividend policy depends on the pecking order theory (Richard, 2008).