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Inside the Mind of An Inside Trader

Juliet White | Photographer's Choice RF | Getty Images

You're a trader at the world's most competitive hedge-fund trading shop.

You feel like you want to puke each morning because the pressure to perform—to outperform!—is intense. Even when you are on top of the market, you worry that there's something you don't know. Something that is going to come charging through the market and destroy you, cost you your job, ruin your reputation, leave you poor, humiliated—and maybe even divorced.

And you aren't on top of the market. It's 2008. The market is, to use an uncommon word, discreating—it is reducing everything to chaos.

Your fund has never had a bad year. But this year that winning streak looks like it will come to an end. The boss, whose name you hardly ever say out loud, is going to fire a lot of people. A lot.

But you've got an edge.

A guy. He knows stuff. He sometimes tells you stuff. The latest trial of a new drug isn't going so well. He knows this, and now you know this.

Shorting this company could make you a hero. A big short position could clear away lots of losses. It would be epic. You would be considered a genius. Everyone would exclaim your market prowess!

But—there's always a but—the boss loves the company that makes the drug. The fund is massively long the stock. The analyst guys have reams of figures showing that it is undervalued by the market. Is there any chance you can change the boss's mind about this?

You send him an email asking for a meeting. And now you are faced with the choice: will you reveal the real reason you want to short the stock? Or do you just try to talk around the information?

In most circumstances, you'd never reveal that you had the confidential information. It's better to be thought of as a genius than a cheater. But this time it's tougher because the boss himself loves the company. He might not listen to your phony reasons for shorting the company. After all—they are phony! He's right. The analysts are right. Based on all the legitimate research, the company is undervalued.

You palms sweat as you walk down to his office. It's time. So what's your move?

(Note: I did have a bit of inside information when I wrote this. I talked to a couple of people who used to work at SAC Capital and a guy who worked at Galleon—none of whom was connected with any of the trading that has garnered the attention of the authorities. This is based on those conversations.)

-by CNBC Senior Editor John Carney

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