Insider Trading Predicted The Last 2 Major Bottoms in The Stock Market!
Yes, that’s true! We have created a database from all insider trading transactions in the last 10 years and we came to the conclusion that aggregate insider trading statistics are very helpful in identifying market bottoms. If we take a closer look at the image on the right, we can clearly see that there were only 2 instances within the last decade when there was more insider buying in terms of transactions than there was insider selling; these moments were the ideal times to BUY the stock market. It seems insider buying and selling can be used as both a sentiment tool as well as a market timing instrument.
Source: Octafinance Insider Transactions Database, Sec.gov & Quandl
Differentiating Illegal and Legal Insider Trading
Making the choice to invest in a company’s stock can be daunting, and requires analysis of a huge volume of information including instances of insider trading. Despite the negativity in the news about insider trading, people will be surprised to know that it is actually a normal part of stock and securities trading, and is perfectly legal when done within the dictates of regulation.
How Insider Trading Can Be Used to Analyze Investments
The nature of insider trading makes these transactions very important to both stock market analysts and investors. Because insiders are in a unique position of obtaining vital trading information, their decisions to add to their stocks within their own company can be very influential to the movement of the market.
For instance, insider buys indicate that the company may make a positive announcement or make public news in the future that can possibly spur on outside buying as investors cash in on the belief that the price will go up. Indeed, if the news is good enough, investor confidence will rise and a positive movement in the stock’s prices occurs as a result.
Analysts also use the instances of insider trading when looking at the overall health of any given company. Some insiders, for example, will want to unload their holdings when the company is in lean financial circumstances. For investors, this can trigger a bearish or a negative attitude towards the company and can result in a lowering of share prices as shareholders sell off their shares to minimize their losses.
What is Insider Trading
The term, in general, is used to describe transactions of any publicly traded company’s stocks or securities by people who are privy to non-public information that involves that said company. In fact, it is similar to any transaction in the market that involves shares that the firm has made available for public trading. The only difference is that insider trading involves key people in the company’s organization, and thus, to ensure fairness and avoid manipulation, these transactions require the filing of certain legal forms in order for the involved parties to avoid legal repercussions.
Who Are These Insiders?
When a company is incorporated, its top management is composed mostly of the people who have signed the incorporation papers. These individuals, then become the majority stockholders and top officers of the company once it goes public with an IPO, through which the public is then enabled to purchase stakes in the company that makes their holders eligible for dividends from the company. After an IPO, there will be hundreds of shareholders who hold shares of stock in the company. However, not all of them are insiders.
The members of top level management are, of course, the most obvious insiders. They are the ones who have the most, if not all, of the information about the company that outsiders can use as basis for their stock trading decisions. However, the term “insiders” can also be extended to people who are holding significant amounts of stock, specifically more than 10% of the total shares in the company, and, to some extent, non-shareholding employees of the firm.
In addition, companies change management frequently. People within the organization are promoted to top management and, more often than not, outsiders whose skills are believed to be beneficial to the company are also hired to a position within the Board of Directors or as an officer of the company. When that happens, the compensation package of these individuals includes the awarding of a large amount of stock in the company. This is also another method through which a person could also become an insider within the company.
Outside of their roles as insiders, these people are similar to other investors. They have the legal right to transact with their stocks, to sell or to buy more when they think that such transactions are necessary to protect their stake in their employer’s company.
When Do Insiders Trade Their Stocks?
The factors that dictate the onset of insider trading are similar to the reasons that outsider trading takes place. In the case of insider trading, buys are considered more significant for purposes of stock trading than sells, although these transactions are also noted with equal interest both by the SEC and individual investors.
What Does the SEC Require About Insider Trading?
As a regulatory body, the SEC requires insiders to make public their transactions in advance. Insiders who plan to purchase or sell their holdings in a publicly traded company will have to file a Form 4. The Form 4 is basically a disclosure that the insider files and one that the SEC makes available to the public immediately after filing.
The whole purpose of the exercise is to make the public, particularly the non-insider shareholders, aware of the transaction so they can take the necessary measures to protect their investments in the company. Form 4 disclosures need to be made within 48 hours directly following the insider transaction, or else the SEC will take note of the transaction and will make inquiries. These days, filing is done electronically so this information is made available to the public earlier than it used to be.
How Prevalent is Insider Trading? Insider Trading Statistics
The public, including even a number of investors in the stock market, are misinformed and are unaware of how prevalent insider trading actually is. In November 2014, for example, the market has seen a total of 2276 transactions that involved insiders adding more to their stake in a company. The shares bought had a total value of US$178.4 million. Insiders sold that same month US$890 million in 7947 transactions. In addition, for that month alone, the total number of insider trading transactions filed and reported reached 10223.
When Does Insider Trading Become Illegal?
While trading their stocks in order to protect their interests in a specific public company is within their legal rights, insiders also have the responsibility of safeguarding the interests of other shareholders in the company. These are the people who have invested their money in small holdings in the firm and whose total investments have been pooled together to generate funds for the ongoing operations of the enterprise.
According to an award-winning study conducted by a few professors at McGill University and NYU’s Stern School of Business, a huge percentage of all public M&A transactions involve suspicious trading practices in some form of insider trading, with only a small fraction of those illegal deals resulting to government prosecution.
The study inspected 1,850 corporate transactions covering 1996-2012. For each of these transactions, the researchers closely inspected and looked for movement or volume abnormalities over stock options for both acquirer and target shares within a 30-day period before the actual announcement of the deal.
Conclusive results showed that approximately 25% of all the deals studied were tainted by abnormal trading prior and up to the day of the deal announcement. The professors added that the odds were pretty slim—3 in a trillion, in fact—that the abnormalities they uncovered were mere instances of chance.
The researchers also concurred that the SEC (Securities and Exchange Commission) only litigated approximately 4.7% of all the 1,859 M&A deals inspected by the study. This disparity is disappointing considering that federal authorities publicly stated their resolve in ramping up their inspection of potential insider trading violations within the last decade. This only means that the results of the study suggest that despite of the few highly controversial cases involving the SAC Capital and Galleon group hedge funds, the government has only flicked the tip of the iceberg.
In essence, insider trading becomes illegal when insiders take advantage of undisclosed company information to strengthen their own positions or the positions of outsiders that they have an interest in, then they are betraying the trust that the other investors have given them. This is when insider trading becomes illegal. The rights of other shareholders become violated as they are not able to take any action to solidify their position and protect their interests as within their right.
Common Patterns of Illegal Insider Trading
The most common form of illegal insider trading is tipping. This happens when an insider, whether an officer in the higher echelons of management, or a rank-and-file employee who inadvertently got hold of this private company information, informs someone outside the company of the undisclosed detail and causes these parties to initiate transactions that can materially affect the price of the stock or take advantage through the stock of price of an event that is unknown to the public or other investors and shareholders.
Take, for example, a company as Company A. Company A is a publicly traded software development firm. Now, Company A was able to close a major deal through which it is going to purchase a smaller software development company that has seen recent success. When the company makes the announcement or when an insider trades publicly, outside investors are going to naturally add more to their investment in anticipation of the impending rise of stock prices. That is the scenario involving a legal instance of insider trading.
Another possible scenario involving insider trading takes place as follows – a high-ranking employee who has access to the information involving the deal accidentally whispers to a friend over a few glasses of beer in the bar that Company A is going to acquire the assets and business of another successful software development firm. This friend, being financially savvy, decides to gamble on that insider information and purchases a significant amount of stock in Company A, and waits to gain profits even before the announcement was made.
With advancements in computer technology, the SEC is able to catch instances of possible illegal insider trading quickly. The most common warning sign is when there is a purchase of a large amount of company’s stock or out-the-money (OTM) options, without public disclosure made in a specific period of time directly preceding the announcement. The SEC’s observations will trigger an in-depth investigation to ascertain whether or not there was an incident of illegal insider trading that has been made.
Penalizing Insider Trades
Insider trading that is illegal in nature is a criminal offense, as it is a betrayal of public trust. The best example of how illegal insider trading can be devastating to a firm, its shareholders and officers is the Enron case. The manipulation of financial information and the case of insider trading, at the final stages of the conspiracy, led to the conviction of Enron CEO Jeffrey Skilling to 24 years in prison, and other sentences for other officers including the late founder of Enron, Kenneth Lay.
At OctaFinance you can not only find insider trading resources, but you can also track all insider trading transactions and news. We also separate the trades by importance and categorize them as follows:insider trading transactions worth $2+ million, insider trades where the insider owns more than 10% of the company and transactions above 2% of the market capYou can also view insider trades in table format.