Insider Tricks Used by Professional Stock Traders

An investor should always be on the lookout for signals that might be clues about their investments. One signal you should be keeping an eye on is the actions taken by the insiders with a company. Are they sticking by the company and investing in it? Or do they seem to be running away from it despite amazing stock prices? These can be important clues as to the health and intermediate future of the company. One thing you need to keep tabs on is whether or not the insiders are buying or selling shares of the company. You’ll also want to note major departures from the company. Of course, the company is going to make up some pleasant story about why some major figure is leaving. You know, they want to spend more time with their grandmother. But is that really what’s going on? If other news or more signals are indicating otherwise, including insider moves, you might view such news with a negative eye. People often leave a sinking ship.

Insider Trading

Here we aren’t talking about criminal activity, but rather a company members themselves who own shares of the company that they are associated with. A good indication that people are confident in the future of their company is finding out that they own and are buying more shares of stock in their own company. On the other hand, if they are selling off their shares, that can be a sign that the people actually running the company or involved with it don’t have that much confidence in its future.

It’s actually possible to find out what company insiders are doing when it comes to shares of stock in their own company. The Securities and Exchange Commission requires them to file publicly available reports. You can find publicly filed reports on a government website known as “Edgar.” It can be found here:

“Insiders” will file various forms, including an initial form that they have to submit to the government indicating their insider status with the company. This is called form 3.

If you are researching this data, you’re going to want to pay special attention to form 4 and form 144. On form 4, any transactions involving a large number of shares are recorded. So, if the insider bought a large number of shares, it would be recorded on form 4. Also, if they sold a large number of shares, it’s going to be reported on form 4.

If a single insider is selling shares, that doesn’t necessarily mean anything. However, if you notice that multiple insiders are off-loading their shares, pay attention. That might be an indication that a large number of people who are in the know about the company’s prospects aren’t confident about the company’s future.

Form 144 is related to a special class of stock called restricted stock. This is stock that the insider was provided as compensation for employment. If they decide to unload it after a required holding period, this will be noted with form 144.

In summary, if insiders are confident that the company is doing well and has solid long-term prospects, they are probably going to be buying shares in the company, not trying to get rid of them. You will want to take this kind of information and incorporate it into the larger picture of course. It’s important to consider all the indicators for the company and not get lost in the details of focusing on one sign. So, if you notice that there is a large sell-off, you’ll want to check other information like the company’s latest earnings reports.

Quantity also Matters

Don’t get alarmed if people sell a small number of shares. When they are trying to divest their own portfolio of any interest in the company, it is when you should take notice.

Congressional Insiders

A few years ago, the news program 60 Minutes did an interesting investigation. They found that members of Congress were playing the role of insiders at many companies and getting advantageous stock buys as a result. Unfortunately, there isn’t much we can do about that, but it’s good to have awareness about it.

Stock Buybacks

Stock buybacks can be a good sign or a bad sign. If a company is doing well, a stock buyback can be used as a way for a company to pass on profits to investors. However, stock buybacks can also be an indicator that a company is heading for trouble. The first thing to consider is that the company has lower than expected earnings. In that case, a company might use a stock buyback in order to artificially boost their indicators on the stock market. Buying back shares of stock, if done on a large enough scale, can alter important metrics like the price per earnings ratio and earnings per share. If you have fewer shares but the same earnings, earnings per share are going to look more favorable. They can do this in the hopes of artificially boosting the value of the stock and hence it’s the market price. Consider an example. Suppose that a company has $500 in earnings and 100 shares. The earnings per share are $5. If they buy back 50 shares, then you still have $500 in earnings, but with 50 shares, so now the earnings per share are $10. That looks better to investors taking a cursory look at the stock, but in reality, the company’s prospects haven’t changed.

Another negative possibility is that the company has stagnated. If companies are out of ideas and not pursuing new ones, they aren’t investing a large amount of money into research and development. That means they have cash sitting around and using a stock buyback could be a simple way to unload the cash.

You’ll also want to check the price-to-earnings ratio and look up to see if the stock is overvalued. It can be a bad sign when a company is buying back overvalued shares.

Another question to ask is, where is the company getting the cash used for the buyback? 

Hopefully, they have enough money on hand to do it. But if they are borrowing money for the share buyback, that is definitely a sign that the company is unhealthy.

If you have invested in a company and they engage in a share buyback, you’ll want to investigate further to find out what’s behind it. In many cases, it’s not something to worry about. However, sometimes it’s an indicator that the future with this company is not so bright.

Stock Splits

Another corporate action you will need to be aware of is a stock split. Companies can do stock splits or reverse stock splits. In a stock split, a share is converted from 1 share to 2 or 3 or more shares. That immediately changes the price per share and impacts metrics like earnings per share. Imagine that a company has a share trading at $100, and it has 100 shares outstanding, and earnings per share of $5, meaning they have a price to earnings ratio of $20. If they do a 2-1 split, now there are 200 shares. The amount of money invested in the company hasn’t changed, so the share price immediately drops to $50 a share. Now you have twice the number of shares in your portfolio, so the value of your investment hasn’t changed. Earnings per share would be cut in half and would be reported as $2.50. The price-to-earnings ratio would remain at $20.

One reason a company might do a stock split is to reduce the price of a share, in order to attract more investors.

A stock trading at $1,000 a share might be unaffordable for a lot of small investors. If a company was interested in attracting more small investors, they might to a 4-1 stock split and drop the share price to $250 per share. A stock split for a high-priced stock can also increase liquidity. That is, it will increase the ease with which you can sell your shares. Very high-priced stocks will have large bid-ask spreads, which can make them harder to sell. Doing a split and bringing the price back down to a lower level can reduce the bid-ask spread and make it easier for investors to sell their shares.

A reverse stock split is going to reduce the number of shares that you own. So, if you own 100 shares and they did a 1-2 reverse split, you would only own 50 shares after that. If the share price had been $100, it would rise to $200 after the split. Remember that the amount of money invested remains the same before and after the split, so the share price also has to change if the number of shares changes.

Learn The Right Investment Mindset By Reading Books

Mindset plays a large role in successful investing. My reading list contains many books on mindset.

A few weeks ago, I read the Rich Dad Poor Dad book and found it quite fascinating.

In Rich Dad Poor Dad, the author explores the steps to becoming financially independent and wealthy using autobiography and personal experience. 

Narrative writing and framework characterize this book. Not technical insights or investment math, but anecdotes with nuggets of supposed wisdom, is the focus of this book.

The author compares his biological father’s (an intelligent, but financially inept father) lessons with the lessons his friend’s father teaches him (an uneducated, but brilliant and wealthy father).

In Kiyosaki’s life, this weaves through as he learns from the rich father and rejects the advice of the poor father (thereby eclipsing typical working-class attitudes).

However, some of the concepts in this book are questionable. Learn more about my thoughts about Rich Dad Poor Dad in my Rich Dad Poor Dad review.

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