Insider Trading Strategy

Using the SEC definition of an insider as a director, manager or employee of the firm, you can compute the percent of stock held in a company by insiders. In companies like Microsoft [MSFT] and Oracle [ORCL], in which the founders still play a role in management and have substantial holdings, you will find insider holdings to be a high percent of the outstanding stock.

In Oracle, for instance, Larry Ellison owned in excess of 20% of the outstanding stock of the company in April 2003. In more mature companies that have been in existence for a while, insider holdings are reported to be much smaller. There are only a few companies where insiders hold 70%, 80% or even 90% of the outstanding stock.

While it is useful to know how much stock in a firm is heldby insiders, most investment strategies are based upon changes in insider holdings. But do insiders trade often enough for this to be the basis of an investment strategy?

Following Insiders:  Timing Is Everything

If insider trading offers advance warning of future stock price movements, can outside investors use this information to make better investment decisions?

In other words, when you are looking for stocks to buy, should you consider the magnitude of insider buying and selling on the stock?

To answer this question, you first have to recognize that since the SEC does not require an immediate filing of insider trades, investors will find out about insider trading on a stock with a delay of a few weeks or even a few months. In fact, until recently, it was difficult for an investor to access the public filings on insider trading. Since these filings have been put online in recent years, this information on insider trading has become available to more and more investors.

An examination of the excess returns around both the date the insiders report to the SEC and the date that information becomes available to investors in the official summary presents an interesting contrast. Given the opportunity to buy on the date the insider reports to the SEC, investors could have marginal excess returns (of about 1%), but these returns diminish and become close to zero if investors are forced to wait until the official summary date.

It is possible that as more and more companies make their filings online, investors will be able to find out about insider trades sooner. It is not clear, though, that the information will translate into higher returns, since all investors will have access to this data.

Key to Insider Trading

The key to success when following insiders is timely trading. Investors may well find that imperfect indicators of insider trading such as jumps in trading volume may offer more promise than waiting for the SEC filings to be made public.

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