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Why Track Insider Trading

Insider trading is one of the least known successful stock market anomalies. It’s managed to beat the market by an average of 7 percentage points annually over the past 50 years. Several peer-reviewed academic studies covering different time periods document the profitability of insider trading. It’s profitable in the United States and in several other developed countries. Perhaps most importantly, it was possible over the past half century to beat the market by imitating insiders’ purchases.

Top officers, members of the board of directors, and 5+% shareholders are classified as insiders. Consultants, lawyers, and underwriters become insiders for short periods of time when they possess market moving information about the companies with which they are affiliated. What makes a person an insider is their possessions of market moving information and fiduciary duty to the shareholders of the company. Possession of market moving information gives insiders an edge over other investors and helps them beat the market.

Insiders also have an edge over retail investors because they usually know their businesses and their industries inside and out. They know what products they’ll be launching, strategies they’ll be pursuing, and which businesses they’ll be acquiring or divesting. Such information is generally not disclosed to the public in detail. It is illegal for insiders to trade based on material non-public information but perhaps more importantly, it is nearly impossible for prosecutors to detect and prosecute such transactions.

It’s possible for insiders to profit legally from market moving information. When they’re in possession of imminent negative non-public information they can postpone their purchases until after the disclosure and avoid losses. The absence of insider buying may be a signal for negative news in some cases. Similarly, when insiders are in possession of imminent positive news they can postpone selling their holdings and indirectly profit from inside information. Drops in insider sales may be a signal for positive news in some cases.

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