Nobody knows what a company is truly worth better than the people running the show. Insiders, defined as company officers and directors plus unrelated 5% or greater holders of a company’s stock, are legally allowed to buy and sell shares. The main restriction they face is holding these share for more than six months if they wish to keep any gains. Sales within shorter periods would require disgorgement of gains.
High ranking officials typically receive incentive stock options or unvested shares as part of their compensation packages. That is why insiders, as a group, always sell more company stock than they buy.
Looking at Insider Transactions
The Thomson-Reuters Insider Transactions ratio measures the current relative Sell/Buy proportion. The number is updated weekly and noted as bullish, neutral or bearish. Heavier than normal buying, defined as less than 12 shares sold for every open-market share purchased, is a good sign. Sales volume 20 times greater than buying volume indicates caution may be advisable.
Signals typically are short-term in nature. Bullish readings generally lead to higher indices weeks to months, rather than years, later. Insider Trading signals generate more false negatives than erroneous positives. The chart below confirms just how accurate and valuable this indicator was during the year ended December 5, 2014.
The Difference Between Insiders and Individual Investors
Insider actions contrast starkly with those of individual investors. Lipper’s equity fund flow data shows that Mom & Pop tend to be net redeemers of stock mutual funds near low points. More often than not, they then re-enter the market only after prices have rebounded.
If you hope to get things right you will need to learn to fight your emotions. For improved results consider increasing mutual fund purchases when shares are cheap. Train yourself to sell only into strength.
The Bottom Line
It makes sense to mimic the people at the top of the investment food chain. Trade like the insiders do and you’re more likely to get gratifying results. Act smarter and watch your net worth grow.
Your psyche and your accountants will both thank you.