How to Track Insider Buying

The legendary Fidelity Investments manager Peter Lynch once said, “Insiders might sell their shares for any number of reasons, but they buy them for only one: They think the price will rise.”

Lynch believed in understanding a company’s product and practices well before investing in it. And as a group, who understands a company’s product, management, and prospects better than its leaders? Investors can legally capitalize on insider knowledge by following public databases that track insider buying. 

Indeed, some may say that tracking the buying activities of a company’s insiders is an integral part of due diligence when investing in a company. Here’s how to do it.

Who Are Insiders and Why Do They Buy or Sell?

The U.S. Securities and Exchange Commission (SEC) defines insiders as the “management, officers or any beneficial owners with more than 10% class of a company’s security.”

Insiders must abide by certain rules, including filing SEC forms whenever they buy or sell shares. In addition, to prevent insider trading or benefiting illegally from material nonpublic information, the law prevents insiders from disposing of shares within six months of their purchase.

This effectively bars insiders from profiting from quick swing trades based on their knowledge. 

What Does It Mean When Insiders Buy or Sell?

As a general rule, insider buying shows management’s confidence in the company and is considered a bullish sign. In other words, the insiders think their stock price is likely to go up. Insider selling is considered bearish; Those in the know may be offloading their stock in an expectation that prices will soon fall.

That’s why many investors keep an eye on the activities of insiders. 

The Post-Earnings Announcement Drift (PEAD) Effect

Many studies have examined the relationship between insider trading, later earnings announcements, and so-called “post-earnings announcement drift” (PEAD). This is a phenomenon where stock prices continue to move toward earnings surprises for weeks or months after the announcement, as if they didn’t already happen. Researchers have generally found that:

• Insider trading before earnings announcements tends to cut the PEAD effect. This likely means the market takes insider moves to signal the coming announcement.
• This is especially true for “contradictory” trades (e.g., insiders buying before bad news or selling before good news).
• The effect is stronger in niche markets believed to have more sophisticated investors.

This suggests that insider trading may improve market efficiency by helping investors better understand the long-term implications of earnings news.

Signaling and Stock Price Management

Other studies have investigated why insiders continue to trade when the profits often seem minimal compared with the risks. Key findings include the following:

• Most insider purchases don’t yield significant profits above market averages.
• Only about a quarter of insider purchases result in abnormal returns.
• This suggests the primary motivation for insider purchases may not be immediate profit.

Researchers have detailed how insider transactions often serve as a signaling mechanism:

• Insiders may buy stock to demonstrate confidence in the company during challenging times.
• These purchases can hint at positive undisclosed information without violating disclosure rules.
• They can help counteract negative market sentiment or high short-selling activity, especially during periods of negative earnings news.
• They’re used as an alternative to traditional disclosure methods like earnings forecasts or conference calls.
• In some instances, insiders may be trying to help build short squeezes for those shorting the company simultaneously as positive earnings surprises happen.

Implications for Investors

These findings have several implications for how investors might interpret insider transactions:

• Insider buying before earnings announcements might signal more persistent or significant news than the market expects.
• The lack of profits doesn’t necessarily mean the insider lacks confidence; It may be a strategic move to signal company strength.
• Investors should consider the broader context of insider trades, including the company’s recent performance and market sentiment.
• While still a helpful indicator, insider transactions should be considered part of a more complex signaling and communication strategy rather than a simple buy/sell indicator.

Insider Buying in the U.S.

For public companies, the SEC requires that all but the smallest microcaps that trade on the over-the-counter boards report insider transactions within two business days. They must file SEC Form-3 at initial ownership, SEC Form-4 whenever changes take place, and SEC Form-5 for any changes that were not reported earlier or were eligible for deferment. 

Form-4 filings can be found in the SEC’s S Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database, a collection of legal filings specific to every company publicly listed on a U.S. stock exchange. If combing through the EDGAR database is too time-consuming, you’re in luck. Many financial news websites track and publish insider transactions.

What Is Form 4?

Form 4 is an SEC form titled “Statement of Changes in Beneficial Ownership.” This form must be filed with the SEC whenever there is a material change in the holdings of a company’s insiders and it must be filed within two days of the transaction occurring.

These forms are included in the EDGAR database. That means they are publicly searchable and accessible, so anyone can view them as they are submitted to learn about changes in insider holdings.

You can search through EDGAR on the SEC’s website. You can look under the company’s name, ticker symbol, or Central Key Index, a value used by the SEC to identify corporations and people who have filed disclosures.

How to Read Form 4

Form 4 is a multipage document that’s relatively easy to read once you’re used to it.

The first page contains basic information about the transaction being reported, including the following:

• The name of the reporting person
• The issuer name and ticker of the security in question
• The date of the first transaction requiring reporting
• The relationship of the insider to the issuer, such as whether they’re a director, officer, or 10% owner

This page will tell you who made the trade, how they relate to the company, and what security was involved.

The second and third pages of Form 4 are used to list the reported transactions, including the following:

• The security
• Date of transaction
• Date the transaction was executed
• Transaction code
• Number of securities transacted and their price
• The reporter’s remaining holdings of that security after the transaction was completed

Page 2 is for securities, while page 3 is for derivatives.

This page outlines the number of securities bought or sold, the insider’s new interest in the business after the trade, and when each trade occurred. The transaction code tells you the type of transaction, such as whether it was a purchase or sale, a grant of shares, conversion, expiration of options, and so on. The instructions for Form 4 outline all the transaction codes that may be used and what they mean.

Explain Like I’m Five

Insiders are people with privileged access to a company’s inner workings, such as its directors and executives. To prevent them from profiting unfairly from their knowledge, insiders are required to file public disclosures whenever they make major trades. These disclosures are available from the SEC and on some investment sites.

For regular investors, those disclosures can reveal what insiders think of their own company’s prospects. A large insider purchase could be a sign that management is confident about their future direction, while an insider sell-off could suggest trouble ahead. The size and timing of a transaction, along with the insider’s history, all play a part in determining whether an insider trade seems positive or not.

The Bottom Line

Insider buying is the legal practice of corporate insiders—such as executives, directors, or significant shareholders—buying shares of their company’s stock on the open market. Investors and market analysts closely monitor this activity since it might offer insights into a company’s prospects. Insiders may buy shares when they believe the stock is undervalued or if they have confidence in the company’s future performance.

These transactions must be reported to the SEC and are publicly available, allowing outside investors to track and analyze this information. While insider buying can be a positive signal, it’s essential to consider any purchases in context. The size of the trading relative to the insider’s existing holdings, the timing of the transaction, and the insider’s historical trading patterns all play a role in interpreting the significance of the purchase.