When we think of insider trading, we’re more likely to associate it with high-profile scandals that expose illegal activity. But in reality, much of it is perfectly lawful. Let’s break it down with a couple of examples (one legal, one illegal) and then look at how retail investors can use insider trading filings to gauge sentiment.
What Is Insider Trading?
Insider trading is the buying or selling of a publicly traded company’s stock or options by someone who has access to material, non-public information about that company. It can be legal or illegal depending on whether the trade was based on information that had not yet been made public.
Legal Insider Trading
Jason, a mid-level engineer at fictional PharmaCo, reads in The Wall Street Journal that the FDA has officially approved his company’s new cancer drug. The news is already public. Excited, he buys 200 shares the same day.
Because the information was public before he bought the shares, and he didn’t rely on inside knowledge, his transaction is legal.
Illegal Insider Trading
Sophie works in the accounting department at fictional EnergyCo. She sees that quarterly earnings (not yet released) are far worse than expected. Before the public announcement she sells all her stock in the company to avoid losses.
Because the information she acted on was material and non-public, trading on it gave her an unfair advantage. This makes the transaction illegal.
Oversight
The SEC (Securities and Exchange Commission) requires company officers, board directors, and beneficial owners of more than 10% of a company’s stock to file a report whenever they trade company shares. These filings are publicly available, providing transparency into when insiders (who often have better knowledge of the company’s performance) are trading.
Gauging Insider Sentiment
There are many reasons that insiders may sell company stock. Diversifying portfolio holdings, buying a home, and paying for a child’s college education are all perfectly valid legal examples. Yet, when it comes to large purchases, there is generally only one reason, and that is the strong conviction that the value of those shares will appreciate.
That’s where Finbotica comes in. We track insider trades for thousands of U.S. stocks and provide email alerts for stocks, automatically notifying youwhen trades occur in the companies on your watchlist.
Insider Trading
About the Author
Van Glass is a software entrepreneur with over 30 years of experience building and scaling software companies with a focus on automation and AI. He is the Founder of Finbotica, where he is developing an operating system for disciplined investing.