Insider trading is a tough topic with a lot of gray areas. In many circumstances, trading on recommendations you listen to or observe is totally legal (albeit possibly risky).
There are a variety of factors that may impact why an insider is purchasing and whether or not you should follow their advice. But how can you know whether something is a solid insider "purchase" and whether you should get involved? The hidden signals hold the key.
What is insider trading?
When someone buys or sells a financial asset using market-moving nonpublic knowledge, this is known as insider trading.
Assume you are an executive of a firm that is planning to acquire another company. It would be considered inside information if it was not made public. It becomes a felony unless you tell people about it, and that friend then uses that knowledge to acquire or sell a financial item or if you execute a deal yourself.
If you're convicted of insider trading, your sentence might vary from several months to more than a decade in prison.
Why does it matter?
Insider trading is not a crime with no victims. Person trading on inside knowledge profits at the expense of others by putting sand in the wheels of financial markets.
High liquidity is a critical feature of well-functioning financial markets, which implies it's simple to conduct huge deals with minimal transaction costs. Insider trading reduces investor profits by lowering market liquidity and increasing transaction costs. Because so many individuals have an interest in financial markets — almost half of American households own stocks directly or indirectly - this conduct damages the majority of people.
Insider trading also raises the cost of issuing stocks and bonds for businesses. If investors suspect that insiders are trading a company's bonds, they will seek a bigger payout on the bonds to pay for their loss, raising the company's cost. As a result, the firm is unable to hire additional employees or invest in a decent manufacturing facility.
Insider trading has far-reaching consequences. It erodes public trust in financial markets and promotes the popular belief that the odds are rigged against everyone else in favor of the wealthy.
Furthermore, some feel the system is rigged since inside traders earn from exclusive access to data rather than labor.
Stock Insiders Will Send Messages!
Investors interested in insider trading might simply purchase what the stock insider is purchasing.
Every week, a slew of "insider buys" lists are published. However, those lists do not tell the whole story. It's just a list of names and share numbers.
What's the real reason behind the purchase?
Here are three of the insider trades' secret indicators that you can use to discover the hidden gems. Insider purchasing will no longer be a mystery once you discover these hidden signals.
3 Secret Signals to Successful Insider Trading
1) "The Lawyer Indicator"
The General Counsel (or "Senior Counsel" in some firms) is the firm's top lawyer and a member of management. As a lawyer, I can attest to the fact that attorneys are often risk-averse. (Excuse me, attorneys!)
As a result, they frequently fall on the side of prudence when purchasing firm shares. They seldom acquire a stock on the marketplace, except their firm is doing something very well.
It's a big covert indication if you observe the General Counsel buying. It's what I refer to as "the lawyer indication." When the attorneys are buying, it's a good time to purchase.
2) Buy When There Are Cluster Trades
The most publicized insider purchases are those made by well-known CEOs who acquire $1 million (or more) in a single transaction.
While these large purchases are fantastic and might indicate something amazing is happening at the organization, I am looking for the polar opposite. I search for "cluster" deals, which occur when many insiders purchase at the same time.
That means three directors, the general counsel, and the vice-chairman of marketing, for example, may all acquire modest amounts of stock at the same time. This form of cluster buying is more uncommon than the CEO's one large purchase, and it sends a strong message.
Is there something all they know?
3) If Insiders Are Investing For The First Time, Buy
Some insiders purchase business stock on the open market numerous times a year. Senior insiders, such as the CEO and CFO, are frequently paid greater than the rest of senior management, and purchasing business stock isn't difficult.
Other senior managers at the bottom of the hierarchy, such as the General Counsel or the Director of Human Resources, may create a separate calculation when considering whether or not to acquire $10,000 worth of shares. Insiders who haven't acquired shares in years, if ever, are not uncommon.
Insiders who have never bought the stock before but are now doing so give a strong signal.
I'm not referring to someone who is fresh to the organization. It would be an employee who has been with the firm for a long time but has only recently chosen to purchase stock.
What is the insider knowledge that hasn't been revealed in previous years? Why is insider buying now? And how would you make the most of this purchasing frenzy?
Where Can You Find the Best Insider Buyers?
Anyone can acquire insider trading information from the SEC website, but searching by specific firms takes time.
Insider buying data is collected by some investing businesses and can be provided to you every week as a list. Have you already seen a list like that? It's easy to become overwhelmed by the sheer amount of businesses available.
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