An Inside Look at Insider Trading—Part Two

02/26/2009 12:01 am EST

Focus: STOCKS

John Jagerson

Co-Founder and Contributor, LearningMarkets.com

As I mentioned in the last Tips for Traders article, insider trading information can be useful, but it can also be overstated or over-relied upon. Used prudently, however, it may alert you to increased risk in stocks you already own, and could even be used to find stocks and options to add to a watch list for potential investment.

I suggest that insider trading information be used in two ways:

Monitoring Insider Sentiment in Stocks You Own

If insiders are suddenly buying a stock you own, it may indicate that there is some very positive sentiment inside the company. That may change your risk control behavior by encouraging you to leave the position uncovered or to add to the position within your portfolio. Before making a decision based on insider trading, however, you should consider who is buying and how much they are acquiring.

For example, if an officer like the CFO is buying, that may be much more relevant than a director. Similarly, if an officer or director is buying very large quantities of stock, that may be something that deserves attention. The stock YHOO experienced significant insider buying by Carl Icahn in his effort to increase his strategic influence on the company's management in late November of 2008. The stock (YHOO) has rallied since.

Using Insider Buying to Find Stocks for Investment

The filtering process to find stocks that you do not already own with high insider buying is daunting if it could not be automated. Fortunately, there are both free and paid services that do an excellent job of filtering and reporting the data for you.

Insider buying should not be the only qualification you use to decide on a company to buy. It is merely an alert that something interesting might be happening. Doing fundamental analysis and making sure a potential investment conforms to your portfolio diversification strategy is still critical.

If you missed it, you can find the first article and video in this series here.

By John Jagerson of PFXGlobal.com and LearningMarkets.com.

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