Insider Trading
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When key executives buy stock in their own company, the SEC requires they know about it. Transactions must be reported within two business days using SEC Form 4. Over a thousand Form 4’s are filed each day. What does this mean? Insider trading (legal that is), can be a viable strategy.
Insiders report each transaction to their compliance officer and they must adhere to a rather lengthy set of regulations. Insiders can only trade on information that is available to the public and it cannot have a direct effect on the stock’s price.
Insiders are also prohibited from realizing profits within six months of a stock market transaction.
The amount of insider trading has not let up, even with increased regulation. Insiders shouldn't be trading with the knowledge of a secret multi-billion dollar deal with the government of France. Their buying & selling is based on the confidence of the company’s future prospects. And that my friend, is how we make money.
Ok, it’s Martha time.
Theoretically, top executives who buy and sell their stock are doing it based on an intimate knowledge of their industry and in one way or another, their company.
Psychologically speaking, how would an executive separate this knowledge to keep within compliance rules? A top executive working for McDonald’s with inside knowledge they were about to buy Burger King, Wendy’s and White Castle would have to keep away from his Fidelity trading account.
However, if this executive felt Big Macs are going to be the Number One burger next year, he can pile on the shares. Separating your motivations to keep legal seems like a gray area to me.
By watching the transactions of high-level execs, you can benefit as well. There is no mathematical formula that alerts you when to buy based on insiders. We do however, have good guidelines based on their past behavior and motivations.
Insider trading is not based on a stock’s past history or a moving average crossover. It’s based on a view from someone very close to a company’s situation.
There are four categories of insiders to be aware of: top executives, officers, directors and large shareholders.
Assuming the best information flows from the top down, it’s the top executives and directors we want to track.
"Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise." - Peter Lynch
Before we go into what to look for, this is where you find it. Each stock on Yahoo! or MSN will have an insider transactions page. But you probably new that. If you’re into research you can scour the EDGAR database of SEC documents.
This is a great source too:
www.nasdaq.com/reference/ownership.stm
When several top executives (CEO, CFO etc..) start dabbling in the stock market about the same time, you have consensus of opinion. Look for these characteristics.
• The stock purchases are at market price and transacted within a short period of time. No more than a week.
• The transactions should be relatively large in terms of share quantity and dollar amount. Ignore small purchases or regularly scheduled purchases. They could be part of a retirement or employee stock purchase plan.
• How many shares do the insiders already own? If it’s their first purchase, they may be new to the company and are required to buy them.
• After the insider’s purchases, was there a marked increase in price?
• Purchases offer more valuable information than sales. If they buy, it’s for one reason. They belive it's going up.
• Sales can be due to an executive’s personal reason. Messy divorce, purchasing a house in the Hamptons or the need to leave the country really fast.
Several executives continuously selling stock within a short time period signal a negative view on the stock price.
H. Nejay Seyhun, professor and author of the book Investment Intelligence From Insider Trading confirms that executives who bought shares of their own stock saw the value outperform the market over the next 12 months. When shares were dumped, their stock underperformed.
Insiders are not day traders. If you buy because they buy, you may have to wait months to see appreciation. As I said earlier, they have to wait 6 months to cash out.
As with anything in the stock market, the appreciation could come earlier. Does anyone really know the future direction of a stock's price?
You might, if you’re an insider. (wink-wink)
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