Where to start with insider trading (2024)

Understanding the basics

At StockTrot, we spend a great deal of time thinking about what corporate insiders are doing and why they are doing it. The Form 4 is our glimpse into their minds. Money speaks volumes and the Form 4 shows us exactly what they are doing with their money, whether they are investing back into their company or selling off their shares. We look at these patterns of buying and selling to assess the executive's confidence in their stock or lack thereof. Studies have continued to show that insiders tend to beat the market when trading their own stocks. To understand why we value the Form 4 so highly, you must first understand, what exactly is a Form 4 and who files them?

You probably know a little about insider trading. There is, of course, illegal and legal insider trading. Illegal insider trading is simply the use of material non-public information to make an investment decision. Legal insider trading on the other hand is the trading of securities made by persons the SEC has deemed "insiders". The SEC declares insiders as directors, officers, or anyone that is directly or indirectly the beneficial owner of more than 10% equity of a registered public company. The focus of StockTrot is legal transactions. It is a long-held belief that insiders beat the market. Insiders know more about their own company than anyone else could ever know and it only makes sense that insiders would know when to get in or out of their own stock. That being said, it is still illegal for insiders to use material non-public info to trade their own stock. There are also certain restrictions put on insiders to prevent insiders from abusing their abundance of information. Nevertheless, they continue to beat the market and that can be very beneficial for you if you know how to use the information.

Why insider trading is important

There's a reason insider trading is on your radar. Insiders know their company well and they use that familiarity to beat the market. Following the actions insiders take can be a profitable strategy. Beyond a monkey see monkey do approach, insiders are a great indicator of the health and future of a stock. Insiders know more about their company than you will likely ever know and it is wise to take their actions seriously.

What to look for

Insiders are required to report both open market transactions (purchasing or selling equity at market value) and others. Others can include such things as gifts, awards, conversion of stock options, etc. A list of transaction types can be found here. While there may be value in evaluating things such as insider behavior with stock options, it is generally much easier and more telling to simply look at open market transactions.

Open market transactions use the transaction codes 'P' (purchase) and 'S' (sale). There are four basic considerations that anyone can use when looking at insider transactions. 1. Insider's role in the company. 2. Clusters of buying. 3. Size of transaction. 4. Price Action

1. Size of transaction

The size of an insider's transaction is a very important factor to consider. Bigger transaction sizes can be a sign of the strength of their belief that the stock will perform in their favor. Not all transactions are necessarily a sign of an insider's beliefs in the future of the stock price. It has been said over and over that insiders sell for many reasons but only buy for one reason, they think the price will go up. While that may be a good starting point for thinking about insider trading, it does not encompass the nuances of insider transactions. When an insider or multiple insiders dispose of a large portion of their shares, they might not all be funding their yacht purchases and rather have a bleak outlook of their company.

2. Insider's role in the company (CFO Buying)

Insiders have varying amounts of information about the health and future of their company depending on the position they hold within the organization. Intimately knowing the direction the company is heading and what events or announcements are scheduled can be very valuable. That coupled with a financial savviness makes for a potentially noteworthy insider to keep an eye on. For that reason, the CFO is likely to be the most telling insider. The CFO knows the company's finances better than arguably anyone and likely understands stocks and market movements better than the rest of the insiders. The CEO is likely a close second to the CFO in these terms. When looking through a companies transactions, a larger weight should be put on when the CFO or CEO purchases or sells their stock.

3. Clusters of buying

There is strength in numbers. While CFO buys can be a good signal, purchases by the CFO, CEO, and other insiders happening in a relatively short timespan can be a very strong signal.

4. Price Action

Considering the price action in relation to the insider transactions is one of the more advanced concepts for evaluating the importance of a transaction. It is a good sign if the stock price is rising and insiders are purchasing or continue to purchase. This could be a sign that even with the increase already seen, they believe the price will continue to rise. On the flip side, if the price is going and insiders are selling, it could be a sign they believe the price will continue to fall. If the price is going up and insiders are selling, this could be a sign the insiders feel the stock is nearing its top and is over-valued. If the price is falling and insiders are buying, it could be a sign the insiders think the stock is bottoming out and will soon be on the rise. Considering the price action when an insider files can be a telling sign especially when the previous considerations are showing strong signs.

Using these considerations allows you to better evaluate and understand what if anything a particular or group of transactions might be signaling. It is important to note that these are a just a few signals that can help you get started understanding insider transactions and is not meant to be a comprehensive list.

How to use insider trading with your existing strategy

Whether you are a fundamental or technical trader, insider trading can be a telling sign worth watching. Insider trading doesn't fit particularly well into either technical or fundamental trading. It is simply in its own category.

Insider transactions can be a particularly strong signal and need to be weighted as such. When evaluating a company with whatever metrics you use, you want to see confirmation from insiders. While a lack of confirmation doesn't necessarily negate your analysis, insiders showing strong divergence from the position you are about to take is notable and should be taken with serious consideration.