Investing Insiders: Does Knowledge Equal Powerful Profits?

Investing insiders are people that have information that is not in the public domain which can give them a financial advantage. It’s a hotly debated topic and most recently has been a social media meme, after a door blew off a Boeing inflight, in which people asking would you be an investing insider if you bought puts on the plane before it crashed. In this guide, we explain more about being an inside investor and whether or not it is worth the risk.

Insider knowledge and insider trading

Whenever ‘insider trading‘ is mentioned, it immediately conjures up the image of FBI officers handcuffing someone from modern buildings. Unscrupulous executives with advanced information profiting from the unsuspecting market. Given the trail of convictions in the past, who can blame the public for this negative connection?

Since the setup of the modern securities exchange system, greedy personnel have been utilising these mechanisms to enrich themselves at the expense of the public. Even more mind-boggling is that even the richest are still conducting these shenanigans. Take Joseph Lewis, the billionaire many times over. Earlier this year, he recently pleaded guilty to insider trading charges after passing vital nonpublic information to his associates to profit from. His net worth? £5.3 billion, according to the latest Times 2024 Rich List.

In the UK, the Financial Conduct Authority (FCA, www.fca.org.uk) also punished executives for profiting from private information. The most recent case is Mohammed Zina vs FCA, where the analyst attempted to profit from mergers and acquisition cases.

There are thousands of insider trading convictions and cases around the world. Undoubtedly insider trading is an ongoing problem. Securities regulators in many countries are reducing this problem with strict regulations about insider trading. For example, the SEC Rule 10b-1 has strict rules about when executives can buy and sell shares during sensitive periods. In the UK, senior executives have to file notices under the Market Abuse Regulations (MAR).

The interesting question is this. Once the insider buying and selling information is publicly made, can investors actually profit from this information?

How should we harness the power of insider knowledge?

Given that most public companies are adhering to securities regulations, most executives are required to file their trading activities.

Once this data is out, many analytics companies hover up these filings and create some form of data trends for investors. This excellent insider trading activity from Barchart.com shows how these transactions are grouped together.

For example, over the last few weeks, many insiders are selling Salesforce (CRM) stock, the tech company. A total of 36 trades were transacted (see below). A further investigation of these transactions shows that many traders were connected to the CEO divesting his stake and directors selling post-vesting.

In other words, these sales have nothing to do with the performance of the underlying company.

Source: Barchart.com

Another example of a major shareholder selling of his company is Amazon.com (AMZN). Jeff Bezos, the former long-time CEO of the internet-based company, sold $8.5 billion of Amazon’s stock to focus on other activities. But this did not crater the tech stock price. In fact, prices have rallied further since his selling to near all-time highs (see below).

Based on the above transaction activities, there are four general observations that I infer from insider buying and selling:

One, insider activity data are only useful at times. Many executives are paid in shares and as soon as they are allowed to sell, many will cash in. This reflects nothing significant on the performance of the company.

Two, the predictive power of insider activities on share prices also varies over time. If a divestment program from a major shareholder is announced, it may or may not rock a share depending on the context. However, if a long-term major shareholder suddenly increases his/her stake significantly, then it may be worthwhile to take notice.

Three, I would pay attention to the share price of a stock since insider trading is a difficult activity to mask. All these transactions will eventually reflect on the price movements.

For example, whenever insiders start to acquire vast quantities of shares, this will immediately increase the buying pressure of a stock and push up the share price. Similarly, if executives and shareholders start dumping stock, then selling pressure exerts a downward movement on share prices.

Hence, if you pay attention to a stock’s share price and become proficient in reading its price charts (old timers call this ‘tape reading’), then you’ll be alerted to this potential buying. And if this increase in buying pressure coincides with insider transactions, it makes the security more interesting.

Four, insider transaction data needs to be used in conjunction to other factors, such as sector earnings or valuation. A CEO buying shares doesn’t mean that the company will not encounter further financial troubles down the road – and vice versa.

In conclusion, while it is true that insiders have better knowledge of the company than the public, one needs to be careful in following their transactions. After all, the market is a weighing machine that will eventually reflect the true value of a company.