Dont people go to jail for that, you say. Yes, some do, although many get off without jail time. Just for the record, Martha Stewart didnt go to jail for insider trading, she got busted for lying about it to federal authorities.
What Im suggesting is perfectly legal and another tool you can use to improve your trading. All you need to do is watch what key insiders of target companies are doing with their shares.
InsidersThe SEC classifies key employees and directors as insiders and requires them to register their trades of company stock with two trading days. For example, if the CEO of a company buys or sells 500 shares he or she is required to notify the SEC within two days of the trade.
That information is public and available to any investor. As long as the insider is trading on information that is generally available to the public no laws are broken.
However, if the CEO knows the company is not going to get a big contract and sells before telling the world, thats illegal.
How to Use Insider TradingIf the trades are legal, what do they tell you and how can you use them?
When corporate insiders, especially senior executives buy or sell company stock, it is worth considering why. Lets look at the sell side first.
The fact that a corporate officer is selling shares may or may not tell you something of value. People sell for a variety of reasons, only one of which may be that the stock is headed down.
Much of executive compensation is in the form of stock so this may be a way of converting that compensation into cash and have nothing to do with the fortunes of the company. The executive may have a tax bill, a divorce, or a vacation to fund. Maybe he or she wants to diversify their portfolio. Frequently, companies will issue press releases detailing why executives are selling to calm fears in the market.
However, if you see several key executives selling at the same time it might be worth taking a close look at the companys fundamentals again.
Insiders BuyingWhen corporate insiders are buying stock, the signals are a little easier to understand. You typically buy for one reason because you believe the price of the stock is going up.
This doesnt mean it is going to pop next week. Frequently, executives buy way out to avoid the appearance of illegal insider trading. However, if key executives are buying stock it is usually a good sign.
Dont be misled by single purchases, however. Most companies require top executives to own stock and will lend them money to buy shares. A new executive may buy a sizable block regardless of the future prospects simply because it is expected.
ConclusionIt makes sense that insiders know more about the company than anyone, so watching what they do is another tool you can use. Here are some points to remember:
- People sell for a number of reasons dont jump to conclusions
- Dont put too much importance on the actions of individuals look for trends
- Insider trading is only one tool, not a magic bullet; use it along with you other evaluation tools