Most investors or traders have heard of “Insider trading” and most of us usually associate this term with illegal trading conduct. In this article I will describe how this is not the whole truth and how you can LEGALLY exploit insider information during your research to find some great trading setups! I will outline my simple yet effective trading strategy based on simple SEC filings.
Insider trading can actually refer to perfectly legal trading activity. For example, it is totally legal when corporate insiders, officers, directors, employees and large shareholders, buy and sell stock in their own companies as long as they report their trades to the SEC. Many savvy traders can benefit from this information to identify companies with investment potential. The idea is fairly simple – learn to read and interpret the SEC filings to get an inside look at what the insiders know! This is fairly intuitive when you realize that insiders know much more than anyone else about their company. So if insiders are buying boat loads of their stock, it is probably a bullish sign of good things to come. Simple right?
So how can you find out the valuable information about insider transactions?
There are literally hundreds of different types of SEC filings which means many hours of tedious boring work right?
Wrong! A sneaky trick that many great traders use to speed up their SEC filing research is that there is really only a small handful of SEC forms that matter for your average trader. I am not an expert on this subject but I would like to share what I have learned about insider trading.
First, all the SEC forms that I mention below can be found at http://edgar.sec.gov/ This article is really only a very brief introduction into using SEC filings to guide trades and is by no means complete. Hopefully I can provide a few interesting tips for you though to help improve your trading knowledge.
The forms that I am interested in are:
SEC Form 4
Form 4: Two main types of transactions are filed on Form 4, these are either Stock option transactions or shares that are purchased/sold (i.e. executive buying or selling). It is important to know what type of transaction is occurring. If an insiders exercises their stock options by buying the stock, you cannot put much weight on this if the options were granted at much, much lower prices. You can tell from Form 4 if he just exercised his stock options or if it is an actual purchase of stock.
Remember that some insiders are more important than others! CEO’s and CFO’s know more than most of the other company directors etc because they are actually running the company and have a much better idea where its financial health may be heading.
Form 8-K: Includes things like press releases, anything important that doesn’t involve actual share sales/buys. Important events are always by law filed with the form 8-K.
8-K must be filed when a ‘material event’ occurs. Simply put, ‘material’ equals ‘important’ in SEC language. One really good tip is to lookout for an 8-K amendment being filed. This form can sometimes indicate that the company has problems or is even fraudulent! This is especially true when a company has to re-state its financial statements of its earning. When this happens it usually means the earnings will be lower than previously states. This is because the numbers were probably faked by the CPA or CEO to make things look better than they really are.
Take home message: an 8-K amendment is really bad even if it is not fraud. It will usually result in the stock trading lower in price, at least in the short term. Perfect information for people wanting to short a stock!
Must read 8-K’s are an absolute must read because often there is some really negative stuff buried in these filings! There has even been open admissions or accusations of fraud or misconduct in the 8-K filings! If you come across one of the 8-K’s which has say a letter of resignation and fraud accusations by an executive or director – you are sitting on a gold mine! Short that stock! Although 8-K’s can be intimidating and boring, it’s not rocket science to interpret them and extract valuable money making information!
Bonus tip: A lot of the major internet based financial quote sites have insider trading information about each stock. Visit Yahoo Finance and select your stockticker, then select menu ‘Insider Transactions’.
Awesome important knowledge: 10b5-1 plans, Here I outline my simple insider inspired buy strategy!
This section contains some information that I consider EXTREMELY valuable.
Q. How do you know when an insider is selling or buying?
A. Because they must by law file a 10b5-1 plan detailing why they want to buy and or sell and you can search on Edgar for these. Do a text search amongst the 8-K’s. Look through the 8-K’s and check the corresponding 10b5-1 plan.
- Basically, if an executive thinks the stocks shares are undervalued then I agree with him! Say an executive of a biomedical company knows that there is going to be good news coming out on a drug – they can LEGALLY start a 10b5-1 plan and go and buy shares of the stock. Some insiders use the 10b5-1 plans to get around the restrictions of insider trading! The cool thing is that you can just look at the 10b5-1 and have the same information as the insider does! Often you can find statements like CEO states He wants cash but he declares ‘he will not sell shares at the current $5 per share and will only sell above $9 per share’. If the stock is at $5 then an easy strategy is to buy and wait for the price to inevitably rise above $9 per share! This of course is not 100% successful but is a great reason to purchase shares of a stock. It is definitely worth doing a ton of other due diligence in conjunction with this strategy.
And there you have it – some simple tips to get you started on SEC filings and how you can easily trade based on these filings. I learned this strategy from one of the top millionaire traders in the world who use to be a CPA. So he has had many decades of reading and writing these filings and he is THE BEST using this information to make millions of dollars a year trading stocks! Check out his profitly chart, subscription service and more information HERE.
Some of the alerts that Superman (Paul Scholardi) has given out in his epic chatroom have been HUGE gainers that he has found by carefully reading the company websites, presentations or 8-K’s. It it these picks that I try to focus on even though they are pretty rare, the profits can cover the cost of membership many times over very quickly indeed.