A:

Insiders often are blessed with owning a significant portion of a company's shares. This shared ownership is often in the form of direct share ownership or through stock options. Since these insiders own - or have the opportunity to own - a lot of shares, it is in their best interest to buy or sell the shares whenever they feel necessary, to realize a profit.

Although some cases of insider trading are illegal, legal insider transactions can take place in two ways: an open-market transaction or a closed-market transaction.

Open-market transactions occur on the open market where average investors put through their transactions. The only difference is that insiders must follow certain rules and regulations that have been set out by the Securities and Exchange Commission (SEC). After filing the appropriate documentation, the order goes through the same as all other orders. The purchase or sale made in an open-market transaction is done voluntarily by the insider, and is not regulated by any company rules. Since these trades are made voluntarily by the insider, they can be used to identify the insider's sentiment about the stock.

A closed-market transaction is the opposite of an open-market transaction. Any trading that is done in a closed-market transaction is between the insider and the company; no other parties are involved. However, as with an insider's open-market transaction, the appropriate documents must be filed with the SEC to show investors that the transaction took place. Most often, closed-market transactions occur when the insider is receiving shares as part of a compensation package or through stock options. As a result, they do not reflect the insider's sentiment toward the stock.

To learn more, see Uncovering Insider Trading, Can Insiders Help You Make Better Trades? and When Insiders Buy, Should Investors Join Them?

RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. What role does the Inspector General play with the Securities and Exchange Commission?

    The inspector general of the U.S. Securities and Exchange Commission (SEC) oversees, audits and conducts investigations of ... Read Full Answer >>
  4. How long does it take to execute an M&A deal?

    Even the simplest merger and acquisition (M&A) deals are challenging. It takes a lot for two previously independent enterprises ... Read Full Answer >>
  5. How is trading volume regulated by the Securities and Exchange Commission (SEC)?

    The U.S. Securities and Exchange Commission (SEC) has trading volume as a requirement for selling securities that are otherwise ... Read Full Answer >>
  6. What do I do if I think an accountant is in violation of the Generally Accepted Accounting ...

    The Financial Accounting Standards Board (FASB) promulgates generally accepted accounting principles (GAAP) in the United ... Read Full Answer >>
Related Articles
  1. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
  2. Home & Auto

    When Are Rent-to-Own Homes a Good Idea?

    Lease now and pay later can work – for a select few.
  3. Term

    Understanding the Maintenance Margin

    A maintenance margin is the minimum amount of equity that must be kept in a margin account.
  4. Home & Auto

    When Getting a Rent-to-Own Car Makes Sense

    If your credit is bad, rent-to-own may be a better way to purchase a car than taking out a subprime loan – or it may not be. Get out your calculator.
  5. Credit & Loans

    Co-signing a Loan? Make Sure You Know The Risks

    Contractually, co-signers are just as responsible for the loan as the person actually borrowing the money. Be careful not to put yourself at risk.
  6. Options & Futures

    An Introduction To Value at Risk (VAR)

    Volatility is not the only way to measure risk. Learn about the "new science of risk management".
  7. Investing

    Looking To Begin Trading In The Stock Market?

    If you are a new trader, we explain the differences between penny stocks and options so you can make the best decision for your personal trade plan.
  8. Investing

    Trends In Copyright Litigation

    The Internet has resulted in an explosion in content. An increasing number of copyright trolls are monetizing such content through litigious practices.
  9. Options & Futures

    How to Trade Options on Government Bonds

    A look at trading options on debt instruments, like U.S. Treasury bonds and other government securities.
  10. Taxes

    What's IRS Form 2848 Used For?

    It's a power of attorney tax form and here's what it can, and cannot, do.
RELATED TERMS
  1. Derivative

    A security with a price that is dependent upon or derived from ...
  2. Security

    A financial instrument that represents an ownership position ...
  3. Series 6

    A securities license entitling the holder to register as a limited ...
  4. Emergency Banking Act Of 1933

    A bill passed during the administration of former U.S. President ...
  5. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability ...
  6. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...

You May Also Like

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!