Insider buying and selling data can be extremely valuable for the individual investor. That is, if one knows how to use that data and interpret it so that a meaningful investment decision can be made.

Insiders (executives and beneficial owners) must file what is called a Form 4 with the Securities and Exchange Commission (SEC). The form essentially outlines the date and price at which a given executive has completed a large transaction in a stock. This data is then used by the investment community as a gauge of insider sentiment.

But what specifically should an investor look for in this information and what should be ignored? Here we'll provide some guidelines for interpreting insider data.

There are many reasons why an insider might sell a stock. The person may be buying a house, have an immediate cash need, or simply be looking to diversify his or her portfolio, which may be heavily tied to the share price. All are legitimate reasons to sell. Therefore, investors should not assume that if an officer of a public company is selling his or her stock that it's a sign shares might be headed for a fall. In fact, the contrary may actually be true. (For more on this, read Insider Selling Isn't Always A Bad Sign.)

Therefore, especially when it comes to insider selling, investors should look for clusters, meaning groups of two, but preferably three or more insiders doing the same thing in order to identify a pattern. That said, on the buy side clusters aren't as important. That's because there is usually only one reason an insider might purchase stock: to make money. (For further reading, check out When Insiders Buy, Should Investors Join Them?)

So, on the buy side, look for individual purchases that are meaningful. A 100-share purchase of a stock probably isn't worth drawing any conclusions from, but if an exec is buying 1,000 shares (at $20 a share), it probably warrants a bit more attention.

Also, consider what, if any, stock the insider holds in aggregate after the transaction is completed. In other words, if the exec sells 1,000 shares but continues to hold another 100,000, shares, this should not be construed as a negative sign. On the flip side, if an exec buys 1,000 shares and he or she already owns 100,000, it is a bullish signal, but certainly not one to write home about.

Diversity in Transactions
Remember that every exec has a different view of the company's future, so look for buying or selling from division heads. Look for the vice president of sales to step up to the plate, or the director of research in addition to the CEO and/or the CFO. After all, if these front-line individuals are buying the stock en masse, it might be logical to assume that the company is headed for better times. Conversely, the opposite may be true if these individuals are selling the shares. (For more on this, see Evaluating A Company's Management.)

Relate Back to the Proxy
When trying to determine whether insider buying or selling is significant, it may help to determine the transaction cost or proceeds, and then put them in perspective to the officer's current holdings. Another suggestion is to look at the transaction in comparison to the officer's annual salary and then determine whether the transaction is noteworthy. Salary information can be found in the company's proxy statement, which is available on the SEC's website. (For more on this research, see Pay Attention To The Proxy Statement and Evaluating Executive Compensation.)

As an example, if an insider is buying $30,000 worth of stock and makes $150,000 a year, that says a lot! But if the purchase totals $1,000, it obviously does not imply the same level of bullishness. The same example is true on the sell side.

Options Exercise
As part of their salaries, senior executives often receive stock options. These options may be exercised at a point in the future and then converted to common shares, which may then be held or sold.

Look to see whether insiders are holding the stock after the exercise, or if they are selling. Keep in mind that selling isn't necessarily bad, because a sizable portion of an executive's net worth may be tied up in the stock. But again, check out the proportion of the transaction compared to the executive's salary and the size of his or her holdings. If insiders continue to hold the shares after the exercise, it is usually a great sign that better times may lie ahead. (To learn about stock options, read The Controversy Over Option Compensation.)

Transactions at Extremes
Are insiders buying or selling at or near the 52-week high or the low? Insider selling near the lows is an extremely bearish signal. Think about it. If you were an insider and your stock had already taken a beating, wouldn't you want to hold onto the shares if you thought that a rebound was likely?

Along those same lines, insider buying near the highs is usually an extremely bullish sign, suggesting that insiders believe that new highs are a distinct possibility.

Bottom Line
Insider data should always be used to compliment the research process, never in lieu of it. Insider data can be an extremely useful tool if you know what to look for, and what conclusions can and cannot be extrapolated from it. So consider the above suggestions - they will only serve to enhance the research process and to help you to make more intelligent investment decisions, particularly when it comes to entry and exit points in a stock.

Related Articles
  1. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  2. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  3. Investing

    Asset Manager Ethics: Rules Governing Capital Markets

    The integrity of the capital markets needs to be kept at utmost importance for all investors. This article shows how to maintain the integrity while investing.
  4. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  5. Economics

    The 5 Countries That Produce the Most Carbon Dioxide (CO2)

    Learn about the top five countries, China, the United States, India, Russia and Japan, that are the largest contributors to carbon dioxide emissions.
  6. Investing Basics

    Explaining the 10-K

    A 10-K is an annual comprehensive report that thoroughly recaps a company’s performance.
  7. Investing

    The Best Strategies to Manage Your Stock Options

    We look at strategies to help manage taxes and the exercise of incentive and non-qualified stock options.
  8. Investing Basics

    Retirement Planning Using Long-Dated Options

    Retirement planning using high-risk options? It is possible, and studies confirm better yields than conventional methods. Here’s how.
  9. Investing Basics

    Understanding Vega

    In options trading, vega represents the amount option prices are expected to change in response to a change in the underlying asset’s implied volatility.
  10. Economics

    Explaining the Tier 1 Leverage Ratio

    The Tier 1 leverage ratio measures a bank’s core capital against its total assets.
  1. Is a financial advisor allowed to pay a referral fee?

    A financial advisor is allowed to pay a referral fee to a third party for soliciting clients. However, the Securities and ... Read Full Answer >>
  2. How often do mutual funds report their holdings?

    The Securities and Exchange Commission (SEC) requires mutual funds to report complete lists of their holdings on a quarterly ... Read Full Answer >>
  3. Do financial advisors need to be approved by FINRA?

    The term "financial advisor" can refer to a couple of different roles. It most often refers to a broker-dealer or an investment ... Read Full Answer >>
  4. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  5. What are the disclosure requirements for a private placement?

    The U.S. Securities and Exchange Commission (SEC) has set forth disclosure requirements for private placements, including ... Read Full Answer >>
  6. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!