Insider Trading Guide
Company managers and board members are skilful businessmen and have a better insight into the performance of their companies than any external stock market analyst could ever have.
Insiders are some of the best qualified people in the world to assess the future prospects of a company or even of an entire industry.
When looking for a company worthy of your investment, you should start with companies trusted by their directors, board members and major shareholders. They put their investments into them because they believe that they can earn more. Insiders will not buy shares if they think their price might go down.
Insiders want to earn!
Everyone who wants to buy shares on the free market does so because they expect that their price will grow - nobody would invest to lose money and insiders are no exception. There are two main reasons why insiders invest into their own companies:
- They believe that the company will soon improve its results;
- They believe that the company is underrated at the moment.
Whatever the reason for a buy may be, people outside the company need to know only one thing - an insider in the company thinks that the price of the company’s shares will go up.
Trade like investors or stock market tycoons
Christopher Brown, a successful investor, used insider trading as the key factor in his strategy for the selection of companies in which to invest.
Peter Lynch included insider trading in his 13 attributes of a perfect company in his book about investing “One up on Wall Street”.
Today, data and tools which were available only to big investors in the past are now available to everyone. Use them!
Analysis of insider purchases and sales
Thousands of insider transactions take place in one day. Unfortunately, you cannot meet individual insiders in person and ask about their reason for a purchase or sale and about how sure they are that the shares will go up. Still, there are signals to follow when choosing the right shares to invest to.
Which insiders do business?
When looking into insider trading activities in a company, first find out who buys. Not all insiders in a company are equal. When considering a buyer look at:
- the insider's position in the company: All insiders certainly have a better insight into the company than we do from outside but the best information is always in the hands of top management. Look at the trading of CEOs, COOs, CFOs, etc. Focus also on the members of the board (vice-presidents, etc.).
- historical performance of the insider: Look at how insiders traded in the past. Some insiders are better than others in identifying and exploiting situations in which the market temporarily undervalued their company. It is likely that an insider who repeatedly managed to use opportunities and make profit in the previous purchases will make profit this time again.
How much money has an insider invested and how many shares have they bought?
The more an insider is certain about gaining in a trade, the more they will invest. When assessing insider investments, always look at:
- the amount in dollars they invested: When an insider is certain that the shares will go up, they make a big investment. Minor or regular purchases of shares mean that the insider participates in the Employee Stock Purchase Program so you can just ignore these.
- a change in the total amount of shares held: Not all insiders are multimillionaires and can invest huge amounts in buying shares. Even a purchase for a small amount can be a significant signal if it substantially increases the amount of shares held by the insider.
Do all buy or just one?
When one insider buys, it represents his or hers confidence in the future of the company but it is important to watch other insiders in the company. If more insiders in a company buy at once, you can be a lot more sure that the price of its shares will go up.
- How many insiders buy? When two or more insiders buy at the same time, it shows that there is a consensus on the future outlook of the company. This reduces the probability that any of the insiders has misinterpreted the situation and increases the chance that the shares will rise in price.
- What was the overall trend in buying and selling? Insiders normally sell their shares more often than they buy them because they receive a part of their bonuses in the form of options or grants. Nonetheless, if insiders sell less than in the past, it is a signal that they are waiting until the price of the shares goes up. This means that they believe that their shares will rise.