What Should I Do When Insiders Are Selling Stock?

It's often said that insider selling can be a hint that they know that their stock is about to underperform the market. Even though this is true in some cases, it's also true that insider selling is frequently simply behind financial reasons of the insiders and have no connection with the company's prospects.

Many company directors and officers do not necessarily have to have the funds to buy shares in the open market. But it is fairly common that companies pay them less on salaries and compensate them with stock shares and options. Therefore their reasons for selling shares in their company may be simply to raise money to pay their personal expenses.

When you see insiders selling a large amount of stock, how do you know it's the time for exit? Insiders are known to sell early so don't panic and try to identify the reason.

Which Selling Is Insignificant?

There are some cases when insider selling can be easily ignored:

• When only one insider is selling, it is likely that it is insignificant. This just reflects the particular needs of one person.
• As there are expiration dates for options, option sales are insignificant too.
• Automatic sales are insignificant because they are based on a trading plan (these plans are known as 10b5-1 plans), which sells at a set point in time established far in advance. They are simply to legally generate income for the insider over time.
• When the selling is done slowly, over a long time frame.
• When the insider has no clear history of selling near the peak of the stock's price.
• When a stock has gone up a bit, an insider may want to take some profits. In such cases, it's even common to see the stock trade higher for a while. Nobody, not even the CEO of a company, can predict the exact top or bottom of a stock in advance with absolute certainty.

Which Selling Is Significant?

On the other hand, there are some signs that indicate insider trading that may be significant and constitute a warning that a major decrease in price can be expected in the future.

• Significant selling is likely to be done in silence, without major announcements.
• The sales are made on the open market.
• The number of shares sold as well as their value is quite large.
• The insider has a previous history of selling near the price peak.
• Lots of company insiders are all selling at the same time or within a short period of time.
• Insiders sell their stock after a major decline in the stock's price. This may mean that they don't think their stock is ever going back up.
• Also when the overall amount of insider trading across the market is rising, it may indicate that the market in general may be about to reverse its course.

Bottom Line

When you find out that corporate insiders are selling stock, don't simply sell when they sell. First try to apply the criteria above to analyze the reason for selling, before you make a decision to stay or run for the exit.