Insider Buying

No review of the stock markets would be complete without some talk about insider buying, which can be an excellent leading indicator to the performance of particular stocks. If the top executives of a company are putting their own money into the company’s shares at market prices, with all they know about the internal operations and prospects for the company, knowledge that is not generally available to the public, then this is a very strong indication that those stocks will increase in value.

As far as the law is concerned, insiders are people who are officers, directors, or 10% shareholders. These are people who know the most about how the business is running. They have material non-public information, which means they have information which is important to the business which is not general knowledge.

The sorts of things which may be known to insiders include how sales have been going since the last quarterly report, whether the competitors in the industry have had any problems, whether there have been any staff changes that would affect the company’s performance, and if they are working on any new products that could have a bearing on the value of the shares. Because it’s obvious that an insider has access to all these details the law requires that when they go to trade the shares, the transaction is reported.

Now you can’t prevent an insider from buying the shares, but ‘insider trading’ is considered to be unethical. The distinction is that insider trading is done solely because of inside knowledge, whereas reportable transactions by insiders are done because of general public information in addition to any other things they know. And share transactions by insiders are perfectly legal as long as they complete the filing requirements.

There are services and newsletters that are dedicated to providing information to subscribers on the insider dealing, but these can run to thousands of dollars a year. Fortunately, the information is available free of charge. If you go to Yahoo.com and click on Finance, you can then enter a stock ticker for a stock quote. On the left column, under the subheading Ownership, you will see Insider Transactions and that will take you to a comprehensive summary of what the insiders are doing in that company.

Of course, just following blindly what insiders are doing and trading on the basis of that is not a good trading plan. You want to look for a sound company with the other features that you would normally consider worth putting your money in. Still, insider buying can certainly be considered one of the several factors that you consider when looking for an indication and confirmation for a trade. The first thing you should look at is how large the purchase is. If it’s not a significant amount, then it doesn’t represent a very large commitment by the insider. But if someone buys a lot of shares, then that shows some conviction that the stock is undervalued.

The second consideration is whether this particular insider is good at picking the highs and lows. After all, we all have different abilities and fallibilities. You can look back over previous trades that this person has done, and see whether they have a history of buying at a low price and selling at a high price. This should give you much more confidence in following them. You can also have more faith in the importance of the transaction if you see that several other insiders are also buying.

There is also a contrarian way of looking at insider buying. Without doubt, we can consider buying when the insiders buy if the stock is trading near the bottom of its range. But if the stock is trading at the top of its range, and perhaps making 52-week highs, then insider buying may be even more significant. The insider is effectively saying that even though the stock is up, they think there is a lot further to go.

If we are considering buying when the insiders buy, then should we also sell when the insiders sell? The answer this is probably not, as the insiders are constrained in what they can do. They are not allowed to sell their shares within six months of purchase unless there is an emergency, when the Securities & Exchange Commission will allow them to sell as long as they do not take the profit. As we are not insiders, but just following their moves, we don’t have this restriction, and can use an exit such as a trailing stop.

As a final note about insiders, you generally should not pay much attention to insider selling. Insider buying must always mean that the buyer thinks the shares are going up, but insiders can sell for a variety of reasons, such as taking money out to pay for a vacation, school fees or a new house. Interesting, but not actionable.

In short, following the insiders is not as difficult as you might think. Some people only put their money into insider ‘sanctioned’ deals, and they make a good income out of it.

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