Insider Buying: What Is It, And How To Use It?
Legal insider buying is when company insiders buy shares of that company based on confidence in its growth and future earnings due to publicly available financial information. If an insider buys shares based on private information and does not report it to the relevant financial authorities, this becomes illegal insider trading.
Insider buying, sometimes referred to as “insider trading”, is when an insider of a company buys shares of the company they are a part of, based on information that is already available to the public. Insiders can include company officers, directors, executives, and major shareholders. If they believe that the company’s shares are currently undervalued and represent a good investment, they can engage in insider buying, which in turn can increase investor confidence.
In this article, Traders Union looks at the definition of insider buying, the difference between insider buying and insider trading, and examples of legal insider buying and illegal insider trading. We also look at insider buying as an indicator for traders and the tools that can be used to track insider buying.
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Who is an insider?
An insider is anybody who has access to company-related information that is not public and could directly impact the price of that company’s shares or influence an investor's decision to buy or sell stocks. This includes company directors, officers, executives, and shareholders with more than a 10% stake in the company.
What is meant by insider buying?
Insider buying, not to be confused with the usually illegal act of “insider trading”, is when a senior member within a company purchases shares of that company. If an insider, such as a director or executive, makes a large purchase of shares of their company based on unique insights and confidence in its performance, then it is referred to as “insider buying”. Individual traders can use significant purchases of stocks by insiders as an indicator for their own trading.
Illegal insider buying on the other hand, more commonly referred to as “insider trading”, involves company insiders making investments made on information that is not available to the public. This is the core difference – investing based on private insider knowledge that gives buyers an upper hand over outside traders is against the law.
Company-related information that has not been made available to the public and could affect the price of the company’s stock, is referred to as Material Nonpublic Information (MNPI). Some examples of MNPI include the unannounced release of a new product, private information on lower-than-expected quarterly earnings, or prior knowledge of the outcomes of a legal proceeding. If an insider uses any of this information to buy or sell shares, before it is made public, then it is determined to be illegal, unless they follow the necessary legal procedures.
When buying or selling shares based on insider information, investors must comply with financial regulations. Insiders in the company – including executives, officers, or shareholders with more than a 10% stake in the company – must file their transactions to the SEC when buying or selling company stocks. The document SEC Form 4: Statement of Changes in Beneficial Ownership must be filed with the SEC, declaring the investor’s relationship to the company. Failure to submit the form can result in legal proceedings.
Legal insider buying
Anyone deemed to be a company insider, from directors to officers to primary shareholders, has to file SEC Form 3: Initial Statement of Beneficial Ownership of Securities within 10 days of becoming an insider. Once an insider, the person can legally buy or sell shares based on insider information so long as they file SEC Form 4 within two business days of executing the transaction.
Legal insider trading is quite common. For example, if a CEO buys back shares in their own company based on their confidence in its future growth, this can be labeled “insider buying”. Similarly, an employee at a corporation could buy a large portion of shares in the company based on its earnings. So long as the transactions are properly executed and reported to the SEC, they remain above board.
Illegal insider buying
Insider trading becomes illegal when the transaction in question is based on non-public information and is not registered with the appropriate regulatory body. If an insider, or someone with access to private information from an insider, buys or sells shares due to private knowledge, and does not fill in the relevant forms, they could face criminal charges. One does not necessarily need to be an insider to be charged with insider trading.
The SEC website lists multiple examples of insider trading violations. It details how any information that could influence a stock’s price or investment judgment of a person making a decision, is “material inside information”. If that information has not been disclosed to the public, and somebody makes a trade based on it, then it is illegal according to the SEC.
Some examples of actual cases of illegal insider trading are; a former board member of a pharmaceutical company in Chile trading with nonpublic information; the wife of an attorney making trades based on information learned from one of his corporate clients; and a family circle all being charged for making illicit profit based on insider information about the future sale of one family member’s company.
As you can see, it is not only company insiders who can be charged with insider trading but also those who they share private information with. It is essential for traders with access to information to follow the necessary legal requirements.
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Is insider buying a good indicator?
Insiders in a company are more familiar with the performance of a company than outsiders. Even if most financial information is available to the public, and earnings are transparent, insiders will inevitably understand company operations better than an outsider. When insider buying or selling occurs, it can be a useful indicator to traders on a stock’s future performance.
If a company insider were to make a significant purchase of shares in their own company, then it is usually a sign that the stock is currently undervalued and signals their confidence in the company’s ability to grow and generate profit. Traders can then use this signal to make an informed decision to purchase stocks.
Similarly, if a company insider were to sell a large portion of their shares, it could signify to the public that they think the stock is overvalued or they believe that the company will be unable to generate positive earnings in the future. This could be used as an indicator to traders that they should also sell their stocks.
Insider buying tracking
Certain online trading platforms feature incredibly useful specialized tools that track the trades of insiders and provide all relevant information about said trades. These tools give invaluable insight into the purchases and sales of stocks made, detailing the size, date, price of the trade, and even the company position of the insider.
Some of the most popular resources for tracking insider trading can be found on websites such as HedgeFollow and Insider Screener, but one of the most comprehensive and easy to use can be found on the Financial Visualizations website FinViz. Traders can see the stock ticker, stock owner’s name, their company position, and the date they submitted SEC Form 4. It details the size and time of the transaction, the price of individual shares, and the total value of the purchase or sale. Having such a useful tool available allows stock traders to make more informed trading decisions and follow general market trends, leading to an overall improved trading strategy.
FinViz’s Insider Trading Tracker Dashboard (Source: finviz.com)
Conclusion
Although the term tends to conjure up negative ideas in people’s minds, most examples of “insider trading” are completely legal when conducted in compliance with financial regulations. It is vitally important for investors and traders with access to insider information to ensure that they fully comply with the relevant legal requirements when attempting to profit from any data that may influence the price of a stock.
Traders looking to gain additional fundamental insight into any given stock’s performance should consider using insider trader tracking, to develop a more well-rounded understanding of it. Traders can also use these tracking tools as part of a larger strategy aimed at finding new trading opportunities based on insider sentiment.
Team that worked on the article
Jason Law is a freelance writer and journalist and a Traders Union website contributor. While his main areas of expertise are currently finance and investing, he’s also a generalist writer covering news, current events, and travel.
Jason’s experience includes being an editor for South24 News and writing for the Vietnam Times newspaper. He is also an avid investor and an active stock and cryptocurrency trader with several years of experience.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO).