Stock Market for Beginners

Insiders might sell their shares for many reasons, but they buy for only one: they think the price will rise”
- Peter Lynch

Insider buying information has been one of the best indicators I have used in my investing strategy to determine which stocks might be on the verge of large percentage moves up. It is prudent to combine insider buying with technical analysis and fundamental research to make a comprehensive and informed investment decision. Even though insider information is just one factor in a complete analysis, it has a strong track record for predicting positive stock performance. Let’s find out why.

Insiders are the officers who run the company, board members who oversee the officers, and 10% owners who have a substantial amount of money already committed with superior contacts and investment researchers. Insiders should know just about everything that is going on about the company they run or have large investments in. Their buying and selling of company stock are well-informed decisions that seem almost unfair. That is why the Sarbanes-Oxley Act of 2002 required insider transactions to be filed electronically and be reported within 2 business days of the transaction date so investors can have more timely and transparent information.

There have been many studies done on the performance of these insider buys which have shown substantial gains, but the most well know research has been done by Professor Nejat Seyhun of Michigan University, and author of the book Investment Intelligence from Insider Trading (The MIT Press, 1998). He conducted a study that tracked more than 1 million insider transactions that took place between 1975 and 1995. Seyhun’s study revealed companies that experienced heavy insider buying and saw their stocks outperform the broader market by 8.9% the following year. Remember, most executives and insiders are spokesmen and salesmen for their companies and will always provide the most optimistic analysis or outlook. But, if an insider makes a financial commitment along with his naturally optimistic chatter, you have a special situation that has historically outperformed the market.

How many times have you heard an analyst on CNBC recommend a stock based on fundamentals and follow it up by saying “there has also been strong insider buying in the last month”? These are professional researchers and money managers from companies like Goldman Sachs, Merrill Lynch and Fidelity. They also use insider buying information as an investment tool. If you follow Jim Cramer of Mad Money fame, you know that he has recommended a number of stocks which he mentioned had large amounts of insider buying.

Even though I have laid out strong case for using insider buying as an investment tool, it is not a fool proof system. In my upcoming articles, I will explain how to pick stocks with the most potential from the thousands of stocks that have insider buying. I will also talk about why insider selling is not always a good sell indicator and which insiders give the strongest indications.

>> Insider Buying (Part 2): Investing Strategies >>

>> Insider Buying (Part 3): More Tips >>

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