Whenever you approach the stock market it's worth considering that the guy on the other side of the trade is probably better informed than you are. When you are buying, he's selling, when you are selling, he's buying. One of you has to be the mug.
While the regulators have done their best to ensure that price sensitive information about companies is fairly disclosed, there are still plenty of individuals who are much, much closer to a company than you are. The closest are known as company 'insiders' who include company directors, officers but also large 10%+ shareholders who may have access on a daily basis to the kind of sensitive business information most shareholders would die for. It genuinely pays to know what they are up to before you make your own moves as they are often acting confidently based upon hard business data.
The tracking of insider trading (more commonly known as director dealing in the UK) has long been known to be a very profitable pursuit. Studies suggest that simple strategies following clustered director dealing can return anywhere from 5% to 10% or so greater than the market averages on an annual basis. The gotcha is that the profits are quite lumpy - sometimes the strategy can underperform for a couple of years before outperforming again - and not many people can handle that.
What works in director dealings?
While the profitability is well known, what is less known are the ins and outs of who's trades are worth tracking and for how long. There have been reams of academic studies since the the 1960s which have aimed to figure out precisely how best to profit from insider trades which we'll summarise briefly today as the rules.
Rule 1: Buy signals are more powerful than sell signals This may seem counter-intuitive, but it's a fact. Most investors are terrified when they see a director sell, but the truth is that selling shares is more often than not for personal reasons (buying a house, diversifying, cashing out options) rather than for reasons relating to the company valuation or prospects. In general there is no correlation with directors sales and lower future stock returns on a per stock basis except when stocks are on very high valuations. In contrast insider purchases do have more widespread predictive value… especially when in unison with Rule 2.
Rule 2: Focus on intensive…
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