Paying close attention to insider buying and selling stock can be a great way to pick up on trends, and potentially beat the market. However, insiders are just like regular investors and they make mistakes, therefore you cannot follow every insider trader.
In this article, we will go over the reasons why insiders buy stock, what it can mean, as well as its importance.
What does it mean when insiders are buying the stock?
Insider buying happens when company executives take their money and invest in shares of the company they work for. This can be an extremely bullish signal for a stock, for two main reasons:
- Insiders have better insights into the business
- Insiders have more industry knowledge
- They have access to more information
- They believe in the business
One of the reasons why insiders buying can be an extremely bullish signal is that insiders often have a lot more knowledge of the company, and the industry. This means that if they are investing in the stock with their hard-earned capital, it’s because they genuinely believe the stock will do well.
This is especially true in smaller companies, where it's easier for top-level executives to have a lot of insights into every aspect of the company.
Another factor that should be considered when evaluating insiders buying, is that they have a lot more knowledge of the industry. This means that if they are buying, they are expecting the business to do well against the competition.
From another standpoint, it is also important to consider that insiders buying will typically mean that they believe in the company. They also have access to more information, which reinforces their decision to buy and gives retail investors confidence in their assessment.
Why would an insider buy shares?
While there are numerous reasons why an insider would see shares, there is only one reason why they would buy - to make money. This is why insider buying is a more important signal than selling.
Insiders can sell their shares for so many reasons that might be personal and are not directly related to managing their portfolios. Conversely, when you buy a stock your main goal is to profit from it, and therefore it shows the market that the outlook is positive.
What does it mean when company insiders sell stock?
While we may be led to believe that insider selling is bearish for the company, it might not be related. Individuals may sell their investments for different personal reasons, and this is why it is difficult to attribute selling to a bearish view of the company.
With that said, if there are several insiders all selling around the same time, this is clearly a bearish signal, and it shows the stock might decline soon.
Is insider ownership good for a stock?
Typically insider ownership is an extremely positive sign. It makes company executives be aligned with shareholders' interests since they are also shareholders. It also shows that insiders truly believe in the business model, and will work in order to achieve the company goals.
Tips to help you understand insider buying
If you are trying to understand the impact or analyze insider buying there are a few questions you should ask, in order to determine if this is a bullish signal.
Who is buying the stock?
High-level management, like the CEO, CFO or COO usually are well aware of how the company is operating. If they buy shares, it is usually a much more positive sign than a board member for example. They run the company and have a direct impact.
How much are they buying relative to their salaries and net worth?
If an insider is buying, you need to determine how much of his own capital is allocated to this investment. Oftentimes you see insiders buying but the value of the investment is relatively low compared with their salaries or net worth.
This might not be such a positive sign. However, if you see an insider buying a lot of stock relative to their salary and net worth, this is extremely bullish.
How often do they trade the stock?
Some insiders will buy and sell the stock frequently, and for that reason, it might not be an important signal that they are buying. Look for individuals that tend to buy and hold shares for a long time.
Why are they buying now?
Another aspect to consider is the timing of the purchase. What is happening with the company that could lead one of the insiders to buy the stock? Understanding this, and trying to think like an insider can allow you to understand if it is an important reason behind the investment.
How good of an investor is this insider?
Lastly, understanding how good of an investor the insider is can also be important. Let’s face it, not all of us are skilled at picking stocks. It is possible for a bad stock picker to invest in its own company stock might not be a very bullish signal.
In order to analyze insider buying, we need to ask a few questions and try to understand the reasons behind the investment. It would far too easy to make money in the market simply by buying every stock, with a lot of insiders buying.
It is more complicated than that, but there are ways to understand what is really happening behind the scenes, and what are the reasons driving insiders to buy.