Insider Buying and Selling
by greencat
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Legal vs. Illegal Insider
Trading 1. It is perfectly legal for insiders to buy and sell stock in their company. In fact, there are thousands of insider trading reports everyday. As long as the insider is trading on information that is generally available to the public no laws are broken.
2. Illegal insider trading is trading based on nonpublic information and may include “tipping” such information. For example, if the CEO knows the company is not going to get a big contract and sells before telling the world, that’s illegal. Yet illegal insider trading is very difficult to prove.
Why Is Insider Trading Important
1. "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, one of the greatest investors of all time)
2. Insiders know their industry, in particular the company they are managing.
3. Insider trading can be profitable only if securities prices move. Therefore, insiders hoping to trade on inside information may try to get the price to move by cutting the company's costs, seeking new products, and so on. While such actions benefit the insider, they also benefit the firm's security holders as a group.
4. No one invests to lose money, so do corporate insiders. They are prevented from buying and selling their company stock within a six-month period: therefore, insiders buy stock when they feel the company will perform well over the long-term
What Do the Researchers Say?
1. When executives bought shares in their own companies, the stock tended to outperform the total market by 8.9% over the next 12 months. Conversely when they sold shares, the stock underperformed the market by 5.4% (Nejat Seyhun, a renowned professor and researcher in the field of insider trading at the University of Michigan)
2. Insider trading is significantly correlated with stock price run-ups implying that insider (i.e., informed) trades affect price discovery differently than non-insider (i.e., uninformed) trades (Chakravarty and McConnell 1997, Financial Management, 26, p. 18-34) 1. When executives bought shares in their own companies, the stock tended to outperform the total market by 8.9% over the next 12 months. Conversely when they sold shares, the stock underperformed the market by 5.4% (Nejat Seyhun, a renowned professor and researcher in the field of insider trading at the University of Michigan
How To Use Insider Trading
1. If key executives are buying stock it is usually a good sign. Don’t be misled by single purchases, however
2. The fact that a corporate officer is selling shares may or may not tell you something of value. However, if you see several key executives selling at the same time it might be worth taking a close look at the company’s fundamentals again
3. It makes a difference which company insiders are making the buys. Top executives (COB, CEO, CFO, COO, President) are the most informed, followed by officers and directors, with large shareholders the least informed as measured by their investment returns.
4. As we look for messages in insider data, the following are important:
- How large was the trade (how many shares or the dollar value)?
- How much of an insider’s holdings were included in the trade?
- Is there a consensus by more than one insider in the company making the same trade?
- Which officers in the company are making the trade?
Additional Reading From the Securities and Exchange Commission (SEC):
Insider trading resources:
Insider Buying and Selling
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