Is insider trading profitable

Talkin go money

In the 1980s, Ivan Boesky was one of the best-known arbitrageurs out there, with an uncanny ability to identify potential acquisition targets and invest before an offer was made. Sometimes his purchases came just days before an unsolicited bid was posted. After hundreds of millions of dollars, regulators finally discovered that his precognition turned out to be fraudulent.

The term "insider trading" is often associated with the likes of Ivan Boesky, but insider trading also refers to the perfectly legal buying or selling of stocks by executives, board members, major shareholders and other investors. privileged with information in a company's stock holdings. While not quite as profitable as Boesky's plan, monitoring these trades has proven its worth in making investment decisions. Or does it have?

Insider Trading Proven Success
Insider trading, legal diversity, is a subject that has been extensively studied by Wall Street scholars. After all, the ability to consistently beat the market over time can be worth big bucks to hedge funds and other large investors. Because such trades were recorded, several studies found that insiders are indeed better informed and in some cases get abnormal returns of up to 30%.

Further research found that non-insiders or regular investors could also achieve similar significant abnormal profits by impersonating insiders. That is, they could buy stocks after the insider purchases and sell them after the insider sales, using publicly available insider trading information. From these studies a home industry of insider trading information providers emerged that still exists today.

Regulators are pulling the plug on the party
The aforementioned studies have shown that insiders tend to be contrary investors who buy stocks after significant price declines such as overreacting to poor earnings reports. Unfortunately, these trends in trade and earnings growth in relation to earnings time led regulators to take action to curb the market abnormalities through Sarbanes-Oxley (SOX) and Regulation Fair Disclosure (RegFD). (To learn more about SOX, please read: How the Sarbanes-Oxley Era Affected IPOs.)

In 2011, Inmoo Lee, Michael Lemmon, Yan Li and John Sequeira published a paper entitled "The Effects". the regulation on the volume, timing and profitability of insider trading. "The general willingness to inform insider trading was found to have diminished over time and the profitability of insider trading completely disappeared after 2002, when regulations were in place.

A silver lining for savvy investors
Investors may no longer benefit from copying insider deals, but they can still provide a variety of clues to support a larger investment thesis; for example, in 2005, Arturo Bris found that enforcing insider deals increases profitability of insider trading in takeover transactions actually increased. Insiders can therefore continue to benefit from non-profit-related events.

Here are a few tips for this new era of insider trading:

  • Find the right purchase . Insider trades are carried out in a number of ways, but the most revealing are "P" trades, which indicate cash purchases of stocks.
  • Look for clusters of buying . Insider deals that take place in clusters and involve executives are more reliable indicators than small one-time purchases by directors or major shareholders.
  • Couple it with a thesis . Investors should try to link insider trading with an overall thesis, e.g. B. in the case of a buyout or an improvement in earnings.
  • Use it as a starting point . Investors can also use clusters of insider dealing as a starting point to further investigate why those insiders are buying stocks.

The tools of the trade
Tracking down insiders can be a daunting task without the right tools. Searching for Form 4 forms in the SEC's EDGAR database is certainly one way to do it, but there are many tools out there today to make life easier. These free and paid online services analyze a wide variety of insider trades, determine the value of the transactions, and offer an easy-to-use user interface.

Here are some of the most popular platforms:

  • Form4Oracle - Form4Oracle is one of the most comprehensive platforms for tracking insider trades with the ability to break down trades by type and monitor insider performance.
  • SECForm4 - SECForm4 is one of the oldest insider trading tool providers with a number of free and paid options including the ability to create graphs to visualize insider trading trends.
  • InsiderScore - InsiderScore is one of the most popular solutions for institutional investors to track not only insider trading, but also hedge funds and other parties.

The bottom line
Insider trading has been a very profitable activity in the past that has produced consistent abnormal returns for both insiders and their external followers. The profitability of insider trading has declined over time and has been largely eliminated after the Sarbanes-Oxley and Regulation FD went into effect. Despite the regulations, there are still several ways that insider trading can be useful for individual and institutional investors looking for profit. Using tools like Form4Oracle, SECForm4, and InsiderScore, investors can quickly and easily find inside information that will help them support their larger investment thesis.