This form of insider trading doesn’t capture the kind of headlines that the illegal variety does, which could explain why the misconception is so common.
Adding to the confusion, investigations of suspected illegal insider trading can take a long time to unveil the truth.
The latest high-profile example led to the dismissal of Equifax’s top three executives following revelations that they sold about $1.8 million in shares of the company between learning about a data breach and announcing it to the public.
What Qualifies as Insider Trading
Both illegal and legal insider trades involve at least one of the following: access to valuable non-public information about a company and ownership of more than 10% of a company’s stock.
A publicly held company’s directors and high-level executives are insiders. An insider is legally allowed to buy and sell shares in the company and any of its subsidiaries, but these transactions require advance filings with the Securities and Exchange Commission.
Usually these trades are prohibited in the days leading up to official announcements of earnings, mergers, spinoffs, reorganizations, and other events the SEC considers to have an effect on stock prices.
The SEC makes insider transaciton disclosures public via the EDGAR database — while you can access it directly via the link in this paragraph, it can be a bit rough on the eyes or at least challenging to navigate.
Easier Reading
Fortunately, numerous third-party publishers make the information easier to access. You can find it through simple Google searches for relevant keywords, and by going to just about any financial news outlet online and looking for insider trade data.
Of course, such a search might turn up news about the illegal variety of insider trading, but it’s fairly easy to tell which kind of information you’re looking at.
A headline referring to investigations or criminal proceedings probably concerns illegal insider trading, whereas in the legal kiund, executives buy, sell, or hold large amounts of shares in the company that employs them.
Insiders generally have more expertise in the company than the average investor does, so that’s what makes their transactions in the stock a strong indicator about the future expectations for the shares’ value.
Research has shown that a stock’s price tends to rise following purchases by insiders, partly due to the fact that other investors tend to follow the trades made by insiders.
However, since not many individuals technically qualify as insiders — in the sense of having large holdings — it can be misleading to only look at insider trading activity within individual stocks as the sole rationale for trading in a stock.
Sometimes insiders might trade for entirely personal motives that outsiders would have no way of knowing.
Instead, consider insider trading one of several factors involved in a stock’s price movement rather than as a single indicator.
The more you learn about the full range of influences upon a stock’s price, the better you can continue to develop your investing chops so you might discover additional investment opportunities in the future.
Look at All Inside Trades Instead
That said, an aggregate look at insider trading 00 across as many stocks as possible — can provide a signal about a possible change in the overall market direction.
And speaking of signals, the ones that the SEC looks for to catch illegal insider trading is a surge in the volume of trades in a particular stock taking place either before a public announcement or when there is no announcement to the public (meaning a secret or rumor is circulating).
These surges became easier to spot once trading began moving away from paper toward electronic format starting in 1971.
Readers, has learning about insider trading made you curious to include it in your own investment research?
Jackie Cohen is an award winning financial journalist turned turned financial advisor obsessed with climate change risk, data and business. Jackie holds a B.A. Degree from Macalester College and an M.A. in English from Claremont Graduate University.
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