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?

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