Does Insider Selling Mean It's Time to Sell?
Actions speak louder than words. While business leaders are happy to tell you all the reasons why their stock is a buy, the actions of company insiders can tell a different story about a company’s investment prospects. While individual buys and sells among insiders is not necessarily noteworthy, a major trend in buying or selling by corporate insiders could provide useful insights into the future of the markets.
There are advantages to using insider selling activity to gauge where a stock's value might be headed, but it's not a perfect method. Be aware of the disadvantages too.
Identifiable trends could indicate how insiders value a stock.
Insiders typically do have better insight.
A trend consistent with other indicators paints a clearer picture.
Reports are public and easily accessible.
Finding trends requires a lot of timely research.
Insiders still can be wrong.
Insiders might sell (or buy) for a variety of reasons.
It's only one piece of information and can be misleading.
Defining Insider Selling
While some trading by corporate insiders can be considered illegal insider trading, most buying and selling by insiders is completely legal. As long as the trades are not made based on material, nonpublic information, corporate executives and others with insider access can legally buy and sell stock in their own investment accounts.
Though it is legal to buy and sell, insiders do have a special set of rules to follow to ensure that everything is fair for regular investors who don’t have advance access to financial results. Because of this, board members and executives at public companies must publicly report every time they buy or sell their own company stock.
There are many legitimate reasons for corporate officers to buy or sell. They could believe the company is headed in the right direction and want to put more of their own money into the company’s stock. They could have received a large number of shares as part of their compensation package and want to sell a chunk of shares to buy a new home or diversify their investments.
But it’s also possible that they know something and want to sell off their shares before the market drops or their company’s stock takes a nosedive.
Where to Find Insider Transactions
Institutional investors and insiders are required to file SEC Form 4. The Securities and Exchange Commission, or SEC, created forms 3, 4, and 5 specifically for insider and institutional stock trade reporting, as investors in those roles have a much greater opportunity to take advantage of inside information for illegal activity.
Informed investors take the time to review insider trades before pulling the trigger and entering their own buy and sell orders. The more information you have when making investment decisions, the better. The SEC created the EDGAR system to give the public access to a wide range of public reports, including Form 4. In addition, the NASDAQ website offers a search feature where you can find Form 4 filings by company.
For example, a wrestling enthusiast looking to invest in their favorite entertainment company, World Wrestling Entertainment (WWE), can quickly view stock trades by CEO (and occasional star) Vince McMahon and other insiders with a couple of clicks.
Both of these systems should provide the same information, so it is up to you to decide which you prefer when searching for insider transactions.
How to Use Insider Reports
If your search for insider trades at a particular company yields several reports, you have the option to sift through the data and look for a trend. If a company shows a lot of buying activity on the insider list, it is a good signal that company leadership thinks the stock is going good places and they personally want in on the profits. A trend of selling activity may indicate that executives think the stock is going down over the upcoming time period and are trying to sell before the price falls.
While you can infer intent based on stock purchasing and selling trends, you never know exactly why the transactions took place. Because you can’t call up the CEO and ask, your best option is to also look at the company’s financial statements, annual reports, and other public information and use that in conjunction with the insider transaction data when making your own investment decision.
What Selling Might Mean
If one executive shows a lot of selling activity, but the others are holding their shares, it’s not necessarily a red flag that something is wrong. If you see a pattern of executives getting stock option grants and then selling a portion, that’s likewise not a major concern. But if you see a pattern of selling across the board without a notable cause, it may be a good time to take note. Some investment researchers look for this type of pattern, particularly when it is not offset by a reasonably similar level of buying.
Two recent examples of insider selling disproportionate to inside buying preceded declines in the S&P 500. In early 2014, the ratio broke 8 to 1 and the S&P fell nearly 6 percent. In 2007, the ratio was greater than 11 to 1, and the S&P later fell 68 points, or just less than 5%.
For Long-Term Results, Focus on Fundamentals
There are many factors that go into decisions to buy or sell stocks. Looking at insider buying and selling activity is an important indicator that may help you predict future swings in stock prices, but you should never look at that alone. Instead, use insider activity as one of many signals in your own investment decision-making system. Also consider a company’s fundamentals, analyst estimates, the most recent news, and what you predict for the company’s future operations.
A company’s fundamentals are ultimately the best indicators of its long-term success. Short-term trading is very risky for investors. If you focus on buying shares with a long-term focus in sustainable, high-quality businesses, your portfolio is more likely to see better results. If you tie all of that together and include insider trading trends as an additional factor, you are even more likely to be on track for great investment success.