12 ways investors can profit via legal insider trading

Insider trading has been top of mind for the past few months with Galleon and Congressional insider trading blanketing the news. While illegal insider trading is being taken to the woodshed, there’s plenty to do with legal insider trading. By following the smart money, investors can follow the cookie crumbs back to the investing profits.

So, here are 12 ways investors can use insider trading data and information to make better, smarter, investment decisions.

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[free webinar] Insider trading strategies: how to follow the smart money

I’m hosting a webinar tomorrow on insider trading strategies — following the corporate insider smart money.

You’ll learn about:

  • recent Harvard research that shows a new insider trading strategy produces 10% of abnormal returns — per year
  • how to identify the smart insiders (versus other noisy trading)
  • the methods to create a portfolio that mimics some of the best
  • other ways to play insider trading (funds, ETFs)
  • the best online tools and resources to bubble up insider trading that really means something

Interested in attending?

>>>Sign up here<<<

[free ebook] The Harvard Guide to Insider Trading

Insider trading (talking about legal insider trading, of course) typically beats the stock market by 10% — per year.

For those of you who’ve been following Tradestreaming for the past couple of years (and read my book), you know that I’m a fan of following the smart money.

By following the tradestream of hedge funds or the activity of corporate insiders, investors can create portfolios  and strategies that have at least been proven in the literature to make money.

Insider trading is a treasure-trove of potentially-profitable information. Top managers at their firms are in the best seats to determine the future prospects for their stocks. If they reach into their wallets and buy their firms’ stocks, well, that’s an incredible useful signal.

An insider trading blueprint

There’s been some amazing research into insider trading. Recent studies have found that investors can mimic the returns of insiders to beat the market by 7 – 10% a year.

I wrote the 20+ page, The Harvard Guide to Insider Trading to describe these strategies and provide a quick blueprint to create portfolios comprised of the most useful insider trading.

AND, to teach you how to use insider trading strategies for your own trading/investing.

You can download it freely here.

I hope you like it — let me know (via email or in the comments) what you think.

Two new ways to invest with an insider trading strategy

Direxion Shares, the fund group known primarily for its leveraged ETFs, is moving into more buy-and-hold strategies.

And the firm is doing it first by launching 2 ETFs that use variants on Sabrient’s Insider Sentiment Index.  Direxion announced that it was floating 2 funds:

  • Direxion Large Cap Insider Sentiment Shares (NYSEArca: INSD)
  • Direxion All Cap Insider Sentiment (NYSEArca: KNOW)

You can see the prospectus for both funds here.
These two funds join Guggenheim’s Insider ETF ($NFO) — also powered by Sabrient’s Insider Sentiment Index.

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A different (better?) way to track insider trading

I devoted an entire chapter in Tradestream to an investing strategy that mimicked insider trading.  You can check out my insider trading dashboard.

Data’s been really good but the methodology is being question by new research.  While previous research (specifically, that done by Seyhun in his book Investing Intelligence from Insider Trading) focused on buckets of insiders (C-level execs, VP’s, external board members, etc), new findings show that investors can get even more granular.

Like tracking individual insiders granular.follow the insiders

In Decoding Insider Information, Cohen et. al. finds that by identifying profitable, opportunistic (individual) insiders, investors can create a portfolio that yields value-weighted abnormal returns of 82 basis points per month.

Instead of grouping insiders together, this study filters out regular, noisy insider trading, of no value to investors trying to find someone trading on better information.  By looking at insiders who trade opportunistically (every once-in-a-while), piggybacking strategies can mimic just those trades that are imbued with meaningful information (assume the insider knows something.)

—> Read Decoding Insider Information (American Journal of Finance)

Follow the Insiders: Insider buying/selling for 3 February, 2011

Today’s important activity

4 microcaps with CFO purchases in the last week (Seeking Alpha)

Insider buying vs. S&P500 (In Search of Alpha)

Insider selling and options trading may spell bad things for Protalix, $PLX (Seeking Alpha)

2 stocks seeing insider buying despite bearish crossovers (Seeking Alpha)

Who’s right: analysts ramp earnings estimates as management gets bearish (Zero Hedge)

Further reading

Read more recent insider transactions

Read more about insider transactions and how investors can profit

Should investors run for the doors when they see an insider hedging?

I’ve written (in Tradestream the book and on this blog) about the abnormal returns of corporate insiders.  Investors following insider moves by following corporate managers’ regulatory filings can capture some of this return.  Read more about my Insider Trading Dashboard.

Essentially, given their stature within their firms and their own profit motives, insider transactions provide relatively accurate signals as to where management sees their stock prices moving.  This strategy is predicated on mimicking insider trading moves that insiders do publicly.

But what if insiders are selling off their stock ownership by hedging their holdings less publicly (in forms 3, 4, and 5 and mostly in footnotes)?

Bettis, Bizjak, and Kalpathy recently published a study on insiders hedging their stock ownership.  In Why Do Insiders Hedge their Ownership? An Empirical Examination, the researchers describe 4 common techniques that insiders use to hedge their holdings and future stock price results depend upon which vehicle chosen:

  1. equity swaps (or total return equity swaps: insiders exchange future returns on their stock for the cash flows of another financial instrument
  2. zero-cost collars: involves a simultaneous purchase of a put and sale of a call
  3. forwards: combines a forward sale of the insider’s stock to another institution, depending upon the value of the stock at a future date
  4. exchange funds: a group of insiders place their shares in a limited partnership or LLC.  By contributing their shares into a diversified portfolio, insiders can diversify their holdings.

Intuitively, the researchers typically found a significant price run-up before these hedging transactions.  Stock performance varied depending upon which hedge was used:

  • exchange funds: stock price continued to climb
  • collars and forwards: saw a reversal in firm performance after the hedge was put on

The big takeaway here for investors is that after a significant appreciation in a heavily management-owned stock, certain hedges can signal opportunistic trading, even if no stock is formally sold.


Why do insiders hedge their ownership? An empirical examination (Bettis, Bizjak and Kalpathy), November 2010