5 Rules of Following Insider Trading

As an investor it is wise to keep track of what insiders at large and small companies are doing. After all, these insiders are executives who should understand their business better than any of the rest of us. Using the trades that these executives make as one of the major tools of your stock investment research is wise. If you are going to follow insider trading when investing there are a few important rules that you need to understand clearly.

5 Important Insider Trading Rules

  1. A Purchase is more important than a sale - Why is this? Quite simply there are all kinds of reasons that an insider would sell a stock, and there is no way of telling exactly why they are selling at the time. Consider the fact that the insider could be selling to fund the education of a child or buy a new home. On the other hand insider purchases are generally more reliable indicators because the main goal in buying a stock is to make money, whether you are an insider or not.
  2. Know the role of the insider who made the transaction - This seems like it should be common sense, but some investors fail to pay attention to this very important detail. Heavy insider transactions by someone such as the CFO or CEO should carry much more weight than insider transactions by someone who is an outside director. Consider how much that insider should know about the current state of the industry and their businesses.
  3. Watch closely for a consensus - When looking for insider transactions that have been filed with the SEC, looked closely for companies who may have had clusters of executives who are buying or selling in a short period of time. The predictive ability of following insider transactions certainly goes up as the number of insiders continues to multiply.
  4. The size of the transactions matter - In order to be able to use insider transactions to help you invest more wisely, you need to know the importance of the dollar value of the insider transactions you are watching. Continual purchases over the span of a few weeks tend to mean the insider is trying to buy in a big way. Also, keep things in perspective by understanding how much of an increase or decrease in the amount of shares owned will occur because of this transaction. The proportionate sizes of the transaction are extremely important.
  5. Understand the time horizon - In general studies have found that insider transactions are much better predictors of long-term movements in a stock than short-term. Insider transactions typically occur a little while before any major movement occurs, so don’t expect a sharp movement in a short period of time.

Keeping track of what insiders are doing is very important, but in order to profit from it you must understand the most important rules of following insider transactions.

Blain here. A very easy way to see what insider transactions are being made is by going to Yahoo Finance, pulling up the quote page for any stock, then clicking the tab on the left sidebar, "Insider transactions."

Aaron K. Smith is a freelance writer with experience working in the mutual fund industry and writing about investing and the stock market. View all posts by Aaron.

Other Recent Posts by Aaron: