directors have access to all sorts of material, nonpublic information about the companies they run. That gives them an unfair advantage when they trade their own shares. So the SEC requires them to file a Form 4 detailing how many shares they bought on what date and at what price.
This doesn’t just sound good in theory. Dozens of studies have shown that stocks under heavy accumulation by insiders outperform the market averages by a wide margin each year. It’s not hard to see why. Insiders know the direction of sales since the last quarterly report, new products and services in development, whether the company has gained or lost any major customers, the status of pending legislation, and all sorts of other relevant data. Riding the coattails of knowledgeable insiders is one of the best ways to outperform the market averages.
However, one of the strategies that offers the highest probability of long-term success is actually the simplest. In fact, you don’t have to know anything about macroeconomics, geopolitical affairs, business fundamentals or Fed policy. All you have to understand is basic human psychology – and the tendency of history to repeat itself.
It works like this. If you see investors scared out of their wits, morose about the future, and taking their broker’s name in vain, buy. And if you hear them confident about their portfolios, optimistic about the future and bragging about the size of their profits, sell. It’s that simple.
The problem is it takes many years and sometimes a decade or more to get these clear-cut, table-pounding turning points. (And we aren’t there right now.) But even when we are there, most investors are emotionally unable to pull the trigger. It just feels wrong to go against the herd. “And besides,” they’ll tell you, “I never expected to see this.” (This, you understand, is something different each time: war, inflation, depression, terrorism, etc.)
If you can move against the crowd, you are that rare breed: a genuine contrarian – and your long-term success is virtually assured. If you can’t, then stick to using value, growth and insider buying.
But make sure to run your stops… because someday in the future investors will once again be scared out of their wits, pessimistic about the future and taking their broker’s name in vain.
And then you’ll have another great buying opportunity.
Related: iShares Russell 2000 Index (ETF)(NYSEARCA:IWM), SPDR S&P 500 ETF Trust(NYSEARCA:SPY), S&P 500(INDEXSP:.INX), Russell 2000(INDEXRUSSELL:RUT)