by Ian Harvey
August 03, 2019
Insider trading information can be a valuable part of your research when trading options, helping you make better informed decisions on your path to success!
An understanding of insider trading is important…..
Inside trading is the buying or selling of a publicly traded company's stock by someone who has non-public, material information about that stock.
Inside trading can be illegal or legal depending on when the insider makes the trade. It is illegal when the material information is still non-public.
Legal Inside Trading occurs when the trading is done during a window of time where non-public information won’t affect the investment decisions of the outside investors.
As well, the SEC considers company directors, officials, or any individual with a stake of 10% or more in the company to be corporate insiders. Corporate insiders are required to report their insider transactions within two business days of the date the transaction occurred.
Illegal Inside Trading is defined by the U.S. Securities and Exchange Commission (SEC) as the "buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security."
……Such as if an employee of a company provides non-public information to his friends to benefit them with trading gains. Examples are…..the CEO or employees of a company sell a stock after discovering that the company will be losing a big government contract the following month, or they provide this information to family and friends.
Reasons Insiders Buy…..
Most traders believe in a market where all information is available to all investors all the time, where the price of a stock is always "perfectly" priced.
But, in the real-world not all things are equal!
Particularly if you can have an edge in the market over your fellow investors, especially if some bombshell occurs…..such as a take-over becoming imminent, accounting investigation, a big contract happening, a positive trial from a drug and many other such instances.
Most insiders buy because they know something good is coming through the pipeline. Other insiders buy because they know people are watching insider buys, therefore influencing the market for their shares.
How to tell whether the opportunity is worth trading…..
When a company insider trader buys the shares of that company, by law they must report the purchase within a couple of days.
When an insider buys because they know something is going to happen, they may not know the exact date it will happen, but they don't care. That's because they know the shares bought are going to rocket higher whenever that announcement or event occurs.
Insiders 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 to look for…..
1. Size of the insider buys. It is important that they are buying thousands of shares on the open market with real money. This real money has to be in the tens of thousands, if not hundreds of thousands of dollars.
2. The insider that is buying should be an executive at the company, not a director.
3. Open market buys, chronologically - again with size and at market prices, preferably at higher prices, by two or more executives.
4. Then, it is important to witness director buys.
5. The best scenario is to see at least five insiders buy shares in sizable amounts before looking at the company.
This kind of information is extremely valuable to individual investors. For example, if insiders are buying shares in their own companies, they usually know something that normal investors do not. They might buy because they see great potential, a merger or acquisition is in the pipeline, or simply because they think their stock is undervalued.
Insider data is nothing new. For years, people have been basing their investment decisions on the actions of insiders. While this data is important, just remember that large companies might have hundreds of insiders, which means trying to determine a pattern can be difficult.
Nejat Seyhun, a renowned professor and researcher in the field of insider trading at the University of Michigan, found that 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%.
Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.