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Stock Investors Should Watch Trades of Key Executives

Legal Insider Trading Can Be Clue to Future Stock Performance

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If the officers of a company are buying or selling shares of its stock, shouldn't investors in the stock market take notice?

Yes, you should. If you are considering buying or selling shares of a stock one of the touch-points in your research should be what insiders are doing with their shares.

I am not talking about illegal insider trades, but the kind certain employees of the company must report.

What I'm 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.

Insiders

The SEC classifies key employees and directors as insiders and requires them to register their trades of company stock within 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, that may be illegal.

You can find insider trades on a number of websites, including Yahoo!Finance. Enter a stock symbol and navigate to the "Insider Transactions" link in the left column under Ownership.

How to Use Insider Trading

If 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. Let's 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 company's fundamentals again.

Insiders Buying

When 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 doesn't 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.

Don't 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.

Key executives also receive options that they may want to convert to stock. For example, I recently looked at a stock that closed slightly over $200 per share. I noticed on the Insider Transactions report that one executive bought a block of stock by exercising an option for about $85 per share. A nice instant profit.

Conclusion

It 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 - don't jump to conclusions
  • Don't 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

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