May 19, 2023 | InsiderSentiment.com Team
Insider trading refers to any trade made by an officer, director, or 10% shareholder in a public corporation of their own stock. Insider trading is regulated and incorporating it into an investment strategy can help boost an investor’s performance due to the insights it provides. Investors may want to subscribe to an insider trading tracker in order to stay current on new occurrences in insider trading or to see high quality analysis of insider trading data. In this article, we discuss the insider trading tracker that is available on InsiderSentiment.com.
Also called the Insider Sentiment tracker, the insider trading tracker on InsiderSentiment.com shows the proportion of companies that are experiencing net insider buying, with some proprietary adjustments made to improve signal.
Academic research by Professor Nejat Seyhun and others has shown for over 30 years that insider trading is a valuable predictor of future stock returns.1
As an investment tool, the insider trading is one of only a few forward looking measures of stock market valuation. Thus, it is important to track insider trading in the aggregate due to the insights that it provides, which is what the insider trading tracker allows. To understand why that is, we should first understand why insiders might trade their own company stock.
Insiders can trade their own stock either for information, diversification or liquidity purposes. Suppose an insider is in possession of some material, nonpublic information that will cause the stock price to move once the market becomes aware of this information. In this case, the insider can beat the market and achieve a better return than other investors by trading on this information in advance of the disclosure. This is called information-motivated insider trading.
Thousands of academic papers show that insiders buy their own stock before a price rise and sell their stock before a price fall. In this manner, insiders capture the rise in price and avoid the fall in price, giving them a superior, or abnormal, investing performance.
However, the possession of material, nonpublic information is not the only reason that insiders trade their own stock. They may also do so for liquidity reasons. For example, if an insider needs to raise cash quickly, they may decide to sell shares. On the other hand, if an insider has excess savings that they want to use up, they may buy their own stock in order to put these excess savings to use.
Insiders may also trade for diversification reasons. When insiders have too much of their wealth tied up in their own firm’s stock, they sell their own stock (typically by setting up a 10b5-1 trading plan to sell on a regular basis) and invest the proceeds in other assets.
When looking at any given insider trade, it is impossible to know if the trade occurred due to the possession of material confidential information, diversification or liquidity reasons. In that case, how can we get valuable insights from insider trading?
To understand how insider trading in the aggregate can provide insights where individual trades do not, we need to understand what makes stock prices move.
According to Seyhun (1988, 1992), changes in firms’ valuations can occur due to market-wide, industry or firm-specific reasons. When insider trading is aggregated across all firms in the market (as we do on InsiderSentiment.com), the positive and negative industry- and firm-specific components of the underlying information cancel each other out, and insider trading closely tracks the market-wide component. This is why the insider trading tracker predicts the future aggregate market returns.
Similarly, when we aggregate insider trading across a sector, insider trading predicts the future returns to that sector. The insider trading tracker on InsiderSentiment.com provides insights because it distills the signal that information-based insider trading provides.
While the signal gained from any one insider trade will be small, aggregating insider trades eliminates the effects from many different reasons (positive liquidity shock in one firm will cancel out the negative liquidity shock from another firm). The resulting signal is a better predictor of the future market returns and thereby allows for trading opportunities for the investor.
You can see this effect in the chart below which compares the insider trading tracker on InsiderSentiment.com (blue) plotted alongside the Russell 2000 Index ETF (in black). You can clearly see the strong negative correlation in effect, especially visible for the most recent data.
When the stock market gets too cheap, the Insider Sentiment tracker goes up, which means insiders are buying more to take advantage of the expected future rise in prices. Similarly, when the stock market gets too expensive, the Insider Sentiment tracker goes down, which means insiders are selling more to avoid the expected future fall in prices.
As an example, take a look at March 2020 on the chart. When the stock market cratered due to fear, insiders were not too scared. In fact, they started buying their own firms’ stock in record numbers, showing the highest level of the index over the past ten years. This is strong evidence that an aggregated insider trading tracker is a powerful forward-looking stock market investment tool.
You can track insider trading on InsiderSentiment.com. Subscribers to InsiderSentiment.com receive access to our proprietary insider trading tracker, called the Insider Sentiment tracker, where we share the signals that insiders are sending, aggregated across different sectors, firm sizes, positive and negative momentum, and value versus growth styles.
Our insider trading tracker allows investors of many different styles to gauge insider sentiment based on their own particular investing strategy. We also provide insider trading separately for each firm on a trade level. This allows stock pickers to take into account insider trading in their potential investment candidates.
Finally, for quantitative traders, we provide a Company Screening tool, which allows investors to generate potential investment leads based on firms characteristics such as market cap, P/E ratio, Book-to-Market Ratio, momentum, profitability, changes in asset size, and of course, insider trading.
Currently, sectors such as Communications, Financials, and Real Estate are seeing increased insider buying. We also see increased buying in small-cap stocks, defined as the firms with a market cap of less than $2 billion. Subscribers to InsiderSentiment.com can see the full analysis as well as which companies within these sectors are experiencing the most insider buying and driving these trends.
To be considered an insider, you either need to be an officer of the company, a member of the Board of Directors, or own at least 10% of the shares of the company. Only a handful of top-level executives in a given company would be considered as insiders.
H. Nejat Seyhun, “The Information Content of Aggregate Insider Trading.” The Journal of Business, Vol. 61, 1988 and H. Nejat Seyhun, “Why Does Aggregate Insider Trading Predict Future Stock Returns.” Quarterly Journal of Economics, Vol. 107, 1992.