Insider trading

The floor of the New York Stock Exchange (Wikimedia image)

Today’s business market is so fast and full of changes that, sometimes, it can be really hard to tell which business investor is reliable. And, what about share purchases made by company executives who invest their money on their earnings calls? These are issues that might seem very unstable to some people, however there are experts who know how to adjust to current circumstances and make the most of them.

The people I’m referring to are called insiders and any insider will sell his share for various reasons, but he will buy them for one, and one reason only: he thinks that their prices will rise eventually. There is not a single insider who won’t evaluate his investment carefully before actually making it, and they rarely make steps without previously thinking about them.

Uncovering Insider Trading

There are a couple of academic studies that support this opinion. When insiders accumulate shares out in the open market, it leads to stock prices rising. This insider advantage is estimated to go as long as 11% higher than the annual market return. However, the founder of a website that follows the market – Insider Monkey, Ian Dogan, warns that your personal mileage can be very unstable and uncertain. Dogan says that the advantage is much lower and that its peak is around 7 % point rather than 11 %, and this is the subject he talked about in his doctoral dissertation which he wrote on insider trading.

All the necessary variables and numbers which are relevant are thoroughly explained on his website, but can be found via other sources like J3SG and SEC Form 4. All insider followers are enabled to go through constantly updated tables which include information about who’s selling, who’s buying, profiles of currently included companies, and a wide choice of screening tools that can help unveil any follow up opportunities. Most of the things that we’ve mention in this text are based on the information from sites like Insiderinsights and InsiderScore, which is most suited for institutional investors.

It is true that anybody who wants can go ahead and log into the Database of SEC’s Edgar and collected the needed data free of charge. However, the editor Meena Krishnamsetty at Insider Monkey, says that it is hard to sort through over 200,000 brand new annual trades. She states that the better option is to let sites like her own dig through the mud and uncover the necessary data you need. All of the three data diggers we checked for this area gather real time insider trade data, give tips on positive aspects and things to watch for, and organize it.

The Value of Insiders

The Securities and Exchange Commission sees all insiders as directors and principal officers of companies. But, it also perceives them as important and influential share owners since they own over 10% of all corporate shares. This means that the total number could sum up to more than 20 job titles, and this includes executive support staff. All of these people are obligated to report their trading affairs on SEC Form 4 within 48 hours after their activity.

Investing as an insider is not as easy as following some random executive and monitoring his shares. Even though insiders have been able to beat the market for the last 50 years in aggregate, they also had some poor performance from 1996 to 1998, and in 2008 as well. Even during successful years, the insider based price depends mostly on the types of buyers and their number, the purchase volume and the unique circumstances that surround each company. Dogan advises that the best thing to do is to look for traces of multiple insiders who plan on buying at the same time. 

A single insider can make a mistake and overestimate certain company’s prospects, while multiple buying insiders will guarantee less risks. This brings us to another important issue: How deep inside is the insider really? The most informed people are the top executives, followed by directors and officers, and the least informed are the large shareholders, based on their investment returns. The executives who have job titles that start with “chief” usually have the greatest operational responsibility, meaning that they also know best where their company’s leverage points are, its performance, and new deal signings.

What the Insider Trading Websites have to offer

Recently, there have been reports of some interesting buying at Insider Monkey website. The Mallinckrodt Pharmaceutical company’s (MNK) insiders bought a great amount of shares in May, November and early December. The company’s shares were brought down during November due to the news of their high priced drugs. Because of the so called cluster buying, more than half of the huge returns were realized by insider trading. This is one of the key factors, and it was backed up by the huge amount of purchases.

SEC Form 4 details data in much more ways and has many more pre-designed lists than Insider Monkey. However, only a small amount of information is available for free. You will have to pay $40 per month for a subscription in order to get any real data. The screeners at SEC Form 4 have bigger search variety than the Insider Monkey’s and have much more valuable information like “significant insider buys.” The tables can also be sorted forward or backward with a simple click on the column heading.

J3SG beats Form 4 the same way Form 4 surpasses Insider Monkey, as it offers many table features and valuable insights. What is even better is the fact that the monthly subscription is cheaper than at Form 4. The site has everything a professional investor would need. However, a lot of the information here is visible only by individual investors that register. The subscription costs $15 per month and it offers many charts, trade alerts, money flow analysis, etc.

Dogan advises that insider buying should be used for investing strategies rather than trading. By definition, insiders are investors since they are forbidden to sell and make profit six months after the purchase. Dogan says that these people usually look to make profit after a year or two. This is something that an outsider might consider too. The best way to look at insider buying is like a signal that can tell you when to accumulate shares and to increase your search efforts on certain stocks.

Some may call having this kind of information unethical and such, however most of the companies have some insider information they use to conduct business. They won’t admit it, but they use it, that’s why it won’t hurt you to use this knowledge in the future. Just remember not to share with other people.

The above article was inspired by recently published article on the same topic in Barron's weekend edition.

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