Moe Zulfiqar: If an executive of a publicly traded company buys or sells shares of their own firm, should this be taken as a signal by investors about what might happen to the stock prices? This question has taken center stage these days, as the markets are reaching new highs on a regular basis and insiders—those who hold some of the key positions in a company—are selling their shares.
According to TrimTabs Investment Research, in February, executives of companies sold $35.30 worth of shares in their own companies for every $1.00 worth of shares they bought. As the firm noted, this was the highest amount since it started tracking insider transactions in 2004. (Source: Taylor, C., “U.S. insider stock sales send up red flag for investors,” Reuters, April 11, 2013.) They were most bearish.
When an executive of a company purchases or sells shares of the company they work for, it is called an “insider transaction.” Insider transactions can happen for many reasons; for example, insiders may sell shares because they might have accumulated a significant number of shares over the tenure of their work and want to liquidate to pay for expenses.
That said, should investors follow insiders at all? The above is true, but investors need to keep this in mind: insiders of a company are usually the first ones to see what will happen to the company in the upcoming future. They find out certain details before investors hear about them.
Now comes the question: how does one actually profit from this? Information about insider transactions is publicly available, but for investors, it may just become a hassle to follow it on a regular basis and keep up-to-date.
One way investors can profit from insider transactions may include the Direxion All Cap Insider Sentiment Shares (NYSEARCA:KNOW) exchange-traded fund (ETF).
This ETF provides investors with the ability to invest in companies whose insiders are accumulating the shares of the firms they work for. In addition, it also screens for companies that are fundamentally strong and have earnings growth. (Source: Direxion web site, last accessed May 9, 2013.)
If an investor goes it alone, looking for individual companies and tracking insider transactions, they have to be very careful. To become better at doing this, they might want to look at companies where insiders are accumulating shares and buying continuously. This hints that they believe in the firm and are willing to put money on it.
Instead of looking at insider transactions in a big-cap company, investors may want to screen companies that are small. The reasoning behind this is very simple: in a small firm, the word may get around quickly, and the insiders might have more responsibility and a better gauge at what can happen next.
Tracking insider transactions and acting upon them can be a profitable strategy, but investors still need to keep their long-term focus in mind. Instead of just buying the shares of a company that the insiders are buying, investors should also prepare for the worst. They need to minimize their risk on an ongoing basis and make sure they don’t overexpose their portfolio to just one stock in hopes of making huge gains.
This article is brought to you courtesy of Moe Zulfiqar from the Daily Gains Letter.