Insider Trading Reports - Useful Sentiment Indicator For Enhancing Your Trades

By analyzing insider trading reports you can intelligently evaluate the stock market and find valuable gems that have yet to be discovered by the masses.

Insider trading reports can form the basis of useful sentiment indicator which covers equity and convertible trades by individuals and institutions who are classified by the SEC as "insiders". An insider is an officer, director, a person with a "policy-making" role, or a beneficial owner (holder of 10% or more) of a company's stock. Insiders are both individuals and corporations. The willingness of management or the company to buy its own stock confirms prospects for an improvement in the company outlook; it may not be a sufficient condition to buy a stock, but it does provide strong confirmation that the stock is a good investment and the downside is often limited.

According to the US Securities and Exchange Commission (SEC) insider trading definition, the term "Insider Trading" can include both legal and illegal conduct.

Legal Insider Trading

Insider activity is perfectly legal when corporate insiders - officers, directors, and employees - buy and sell stock in their own companies and report their trades to the SEC according with the rules - they can only trade if all insider information they have is already public and they have to report their direct and indirect holdings of the company's stock within two business days after purchase.

Illegal Insider Trading

When insider trading refers to buying or selling a security while having nonpublic information about the security, than it refers to illegal insider trading, which weakens investor confidence in the fairness and integrity of the securities markets and is therefore strictly prohibited. Illegal insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information.

Examples of following illegal insider trading reports:

  • Corporate officers, directors, and employees who traded the corporation's securities after learning of significant, confidential corporate developments.
  • Friends, business associates, family members, and other "tippees" of such officers, directors, and employees, who traded the securities after receiving such information.
  • Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded.
  • Government employees who learned of such information because of their employment by the government.
  • Other persons who misappropriated, and took advantage of, confidential information from their employers.

Martha Stewart Insider Trading

A real example case of illegal insider trading:

In 2001 the Food and Drug Administration (FDA) announced that it was rejecting ImClone's new cancer drug, Erbitux. As the drug represented a major portion of ImClone's pipeline, the company's stock took a sharp dive. Many pharmaceutical investors were hurt by the drop, but the family and friends of CEO Martha Stewart were not among them. She sold 4,000 shares when the stock was still trading in the high $50s and collected nearly $250,000 on the sale. The stock would plummet to just over $10 in the following months. Martha Stewart claimed to have a pre-existing sell order with her broker, but her story continued to unravel and public shame eventually forced her to resign as the CEO of her own company. Martha Stewart and her broker were found guilty of insider trading and ended in prison and fined.

Following Insider Trading Reports Guides

Following insider trading reports may be a valuable tool that helps you enhance your trades. Since insiders are prevented from buying and selling their company stock within a six-month period, insiders buy stock when they feel the company will perform well over the long-term. It is important therefore to remember that most insiders are investors, not traders and they tend to buy shares in the company when they are cheap and sell when they are expensive. They are not as motivated by trends as are traders.

Here are some guides for building investment strategy based on following insiders:

  • Stock purchases by company officers are more important than those of other insiders (directors and beneficial owners). Corporate officers know their business the best, they are the people who manage the company and know the day-in and day-out operations of the company.
  • Insiders buying activity sends a much stronger message then insider selling activity; insiders might sell their shares for any numbers of reasons, but they buy them for only one: they think the price will rise. The history shows us that traders who took cues from insiders when they bought have made excellent returns in bull markets, while it was also a good strategy even when you have been trading against the trend.
  • It is more intriguing to see clusters of insiders buying their own company's stocks within a relatively short time rather then just one.
  • You should check the relative size of purchase amount - compare it with the executive's compensation level and with insider's existing stock position. For example, if insider doubles his net worth position or if the amount he buys is more that his annual salary, you should consider that significant. On the other side, when someone added just a small worth of stock to his existing position or the invested amount is presenting just monthly salary of the insider, we cannot say this was an impressive trade.
  • There are a number of other things you should discover while picking stocks based on insider trading reports, especially trading history and pattern of insider trading. Did the insider have a successful trading history? Are insiders enthusiastic about their own company's stocks? Did the insider buy at a higher price but not continue to buy at much lower prices? Is the insider selling shares that he bought at higher prices?

Following Insider Trading Reports Statistics

According to some existing academic researches, when executives bought shares in their own companies, the stock tended to outperform the market by 8.9% over the next 12 months. Conversely when they sold shares, the stock underperformed the market by 5.4%.

Note that insider stock trading activity should not be used as a single indicator when deciding to buy or sell a stock. You should take this information as a good starting point to further research the company with other analytical tools, like fundamental or technical analysis for example.

Recommended Reading

If you would like to get more in-depth insight and expert advice about following insider trading reports, we recommend you to read the book The Vital Few vs. the Trivial Many: Invest with the Insiders, Not the Masses written by investment professional George Muzea. By reading the book you'll discover how to look past media hype to discern what the Vital Few or corporate insiders - those who know their companies best - are doing. By explaining which information is accurate and valuable, as opposed to that which is misleading and financially hazardous, you will learn how to successfully and intelligently evaluate the stock market and find valuable gems that have yet to be discovered by the masses.

Where To Find Insider Trading Reports?

With the click of a mouse, anyone can find the latest insider trade data for just about any public company. Here are a three interesting websites that provide insider-trading reports:

SEC EDGAR Database

While not visually appealing, this is where trading data is first sent. To find these filings on the SEC website, you must search for the central index key (CIK) for the company. The CIK is used on the SEC's computer systems to identify corporations and individual people who have filed disclosure with the SEC. Once you have the CIK, you can search for individual filings at: www.sec.gov/cgi-bin/srch-edgar.

Yahoo! Finance

Look up any quote on Yahoo! Finance and click on "Insider Transactions" for a list of the latest trades. Some insider trading filings don't appear in databases until a month after the fact, but Yahoo seems to have one of the most current data feeds.

Insider-Monitor.com

Insider Monitor is publishing a number of insider stock trading reports to help analyzing insider buying and selling activities. Some of the reports include real-time insider stock trading report (lists insider stock purchases within minutes as they are reported to the SEC), top 10 insider and insider officer buys of the week and month, top 10 insider sales of the week and month and others.

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