Insider Data: An Information Flow To Know!

The following is excerpted from the book "Profit from Legal Insider Trading"

Every day, individuals have the opportunity to invest in more than 15,000 U.S. stocks. But such a huge opportunity is also hugely confusing. How do you start narrowing down your investment choices?

Value investors may start by looking for stocks with low price/earnings or price/book value ratios. Growth investors likely head to the quarterly financial results in a newspaper looking for stocks with great year-over-year earnings comparisons. Momentum investors probably prefer to look at the "percentage gainers" list, and stocks with large trading volume increases. But all of these investors could increase their returns if they started their stock picking by looking at the same information flow: insider trading data.

That's right. It should come as no surprise to anyone that insider trading occurs every day in the stock market. What might surprise investors is that most of it is done with the full knowledge and sanction of the U.S. Securities and Exchange Commission (SEC). So blatant are these insiders, they actually tell the SEC what they do.

This isn't the sort of insider trading that has made Ivan Boesky infamous. He profited from trading on material, non-public information provided to him by a network of informants. The activity we refer to is the trading by directors and executives in their own companies' shares. This "insider trading" is not only legal, it is reported by executives to the SEC via a document called a "Form 4".

This legal insider data, and that provided by other SEC documents, is a great source of investment ideas no matter what style you prefer. It's also invaluable for following stocks you already own. After all, who's in a better position to know a company's prospects than its own management? Corporate insiders obviously have access to the same material, non-public information that sent Mr. Boesky and his friends to jail--only they can act on it in many cases!

Obvious abuses by corporate insiders, such as purchasing large amounts of shares just before their company is acquired at a premium, still aren't allowed, of course. Most publicly traded companies now also have internal guidelines that only allow their executives to trade during certain "windows" of time. But an executive can hardly forget what he or she saw in the last sales report or heard in the last strategy meeting when on the phone to a broker. There is undoubtedly plenty of important, non-public information influencing insiders' investment decisions regarding their own firms' shares.

By analyzing the Form 4s filed at the SEC, you may not know what these insiders know, but you can certainly know what they do. And this information is arguably just as good.

Academic studies have proven that this SEC data is useful for garnering "excess returns" in stocks. A more important testimony comes from institutional investors, many of whom have successfully used the SEC's insider data to help make their investment decisions for years.

In fact, professional investors have enjoyed timely access to the SEC's insider trading data for decades, finding it lucrative to pay what it takes to access the most up-to-date detailed electronic databases. Starting in the early days of computers, institutional investors paid private firms to manually key in Form 4 and other insider trading data from the original paper forms filed with the SEC. By the time individual investors got hold of the affordable public versions of the data from the SEC itself or free websites, institutions had already traded on the information. Perversely, the data that was meant to level the playing field for individual investors was giving institutional investors yet another leg up. That situation lasted well into the 1990s.

But the Internet, the SEC's "EDGAR" system for filing various financial forms electronically, and the passage of Section 403 of The Sarbanes-Oxley Act back on July 30, 2002 has leveled the playing field tremendously. It's still worth paying a bit of money to a service to get the raw insider data organized well to save you time, but the cost has come way down. And this data flow was already profitable to follow with the old 10 to 40 day time lag, but with the filing deadline for Form 4s now just two days it's even more so.

Now that you understand more about what a Form 4 is, you have to know how to use it. As an investment tool, it is obviously more involved than just blindly mimicking the trades of a company's chairman. Some insider signals and patterns are important, while others are just time-wasting noise. "Profit from Legal Insider Trading" contains chapters on how to help separate the noise from the truly useful insider signals, and InsiderInsights' Newsletter discusses real-life examples of important insider patterns in most issues. If you have questions about these products, or our value-added data modules, feel free to Contact Us to help determine what subscription level is right for you.