Insider trading. There I said it. No, you’re not going to jail just for reading it…
There are actually two types of insider trading: illegal and legal.
Insider trading is defined as the buying or selling of a stock by someone who has access to material, nonpublic information about the stock.
Insider trading is illegal when disclosure doesn’t happen before the trade. Insiders must disclose the information to the SEC before they make the trade. They also have to publish it on the company’s website, but the ability for consumers to easily see it most often doesn’t happen. If this is not done, the transaction is illegal and the insider can be fined or put in jail. Most people think Martha Stewart, but she actually was convicted of obstruction of justice.
Legal insider trading happens every single week on the stock market. Simply sending the information to the SEC and posting it somewhere on a website makes it legal. (Still makes it hard to get information…)
Why Insider Trading Is Important
Ken Lay, the Founder and CEO of the company, was sending out letters to shareholders and messages to employees like “The company is fundamentally sound. At current stock prices . . . this seems to be an incredibly cheap stock.” He urged them to buy more and more shares of stock (which pushes the price up). Meanwhile, the company was effectively burning to the ground. At the same time that Lay was telling all of the employees that everything was great, he was selling off all of his stock.
Though this was a huge scandal, small things often go unnoticed by the public.
As far as I’m concerned, I don’t care what the insiders know. All I know is that if they are buying a large number of shares or selling them, they know something I don’t know and it’s usually important.
Historically, we can see large purchases before stock prices go up and large sales before they go down. That makes a great indicator.
The other reason we want to know about insider trading is it also tells us about insider ownership.
I read a statistic in an insurance journal a few years ago that said that 86% of accidents by teenage drivers were in cars that parents bought. It got me to thinking about my own children. (I have 4 of them.) They tend to take way better care of the things that they work and pay for. If there’s no skin in the game, it doesn’t mean as much.
The same is true with the insiders. If their wealth and/or retirement is invested in the company they work for, they have skin in the game and are much more likely to take better care with the company.
What You’ll See
Inside the Stock Value membership, we track insider trading. When you run a search on a stock, you’ll see a chart like the one above letting you know about any recent purchases or sales by the people that control the company.
If you haven’t already, this is another reason to enroll now.