Insider trading can be a significant tool at your disposal in terms of indicating a stock’s future direction. However, insider trading data is full of noise and most of it actually doesn’t mean anything, contrary to what many believe. To really have an edge over others, you need to act like a detective looking for clues among all the noise. It’s a fun game.

In case you don’t know, SEC form 4 is the one that is most important in terms of insider trading. I like to spend a little time on weekends to review last week’s insider activity by looking at all form 4’s.

Here are a few random tips to find your way around them:

- First and foremost, insider activity is not a technical indicator: You shouldn’t buy or sell a stock purely based on insider activity. It should be part of your “due diligence”. Insiders can be wrong just like anyone else.

- Buys are much more important than sells: An insider can sell for any reason. For many companies, the stocks held by an insider may represent most of his net worth. So it just makes sense to take some of it out and diversify. Or buy a car. Or a house. You get the point. However, when an insider makes a purchase in open market, it means only one thing; he thinks the stock will go up.

- Only look at open market transactions: For example, insiders may be able to buy a stock 15% cheaper due to their stock purchase program. This means very little in terms of future direction. However, if the stock is purchased in open market, that is, within the price range of purchase date, it means much more. You need to look at “Transaction code” column in form 4 and make sure it is “P” for open market purchase or “S” for open market sale. Ignore others.

- Option-related trades are mostly insignificant: Most insiders have options in company’s stock, as in they are able to buy at a certain strike price and sell at open market. You will see that most insider transactions are like that, it involves a purchase at a low price then an immediate sell at a much higher price. There is not much to see here, the insider has a big risk-free profit and he’s taking it. However, there are a few red flags:

• Is the insider exercising options way early before they expire? In the SEC filing, you will see the expiration date of exercised options. If they were exercised, say, 6 years before the expiration, then this transaction deserves extra attention.
• Is the option being exercised very close to strike price? If the option is granted at $20 and the insider is in a rush to flip it the moment stock hits $22, that is clearly a bad sign and indicates low expectations.
• If an insider buys the option-related shares close to expiration but doesn’t immediately sell them, that is a huge plus. Happens very rarely but the fact that the insider chose to not take the free money and let it ride means a lot.

- Check how many shares insider still holds after a sale: I said sales aren’t as important as buys but this can be a big red flag. On every form 4, you should see the insider’s remaining shares. If you see that he is getting rid of most of his holdings, or worse, hitting 0 shares, there may be something going on.

- Look at the relative worth of new shares purchased for a particular insider: The CEO may be holding a million shares and he may get 50k more, that doesn’t mean much compared to a director holding 50k shares and getting 50k more. It indicates higher conviction.

- Transactions by high-ranked insiders are more important: A CFO will have a much better understanding of the business than a 10% holder.

- SEC filings are prone to errors: There are quite a few cases where you see a P symbol instead of S or see an extra 0 somewhere. This is purely human error as filing SEC forms is a cumbersome task (If I was doing something illegal, I wouldn’t report it at all). It will most likely get amended soon in another form. Just be aware of this and if you see something funny looking, there is a chance it’s just a mistake.

- Disregard initial purchases: If this is the first share purchase of the insider (going from 0 to X shares, unless he sold earlier), it doesn’t mean much. When you get an insider status at a company, it only makes sense to purchase some shares.

- If a small cap stock recently made a huge run, look for insider sales: Happened recently in DRAM, RWC, CNLG etc. There were lots of dreamers out there who were thinking these are 10x baggers while insiders sold into the spike right away. Who do you think was right? This is probably my favorite usage of insider data as I can combine it very well with my main trading method of shorting fluffy momentum. What this type of sale tells me is simple: There is no other big catalyst in the immediate future, meaning it’s safe to short. Some stocks can’t stay up without catalysts.

- Remember that insiders can’t swing trade: If an insider buys shares, he can’t sell for 6 months for profit. When he sells, he has to give the profits back to the company. So, don’t expect miracles right away when you see insider buys. If the buys are convincing, put the stock on your watch-list and look for potential catalysts in the mid-term.

- An insider transaction is more helpful in avoiding bad trades than making good trades: If I see an insider buy at a company that I think is worthless, I will stop thinking of going short. Straightforward. Make insider trade search part of your DD process.

- Price level of where transactions happen (or don’t) is important: If a stock is down 30% from its highs and there are still insider sales, it’s a bad thing. If you think a stock has bottomed out mid-term but there are still no insider buys, it’s also a negative. If there is steady buying during an uptrend, well, I don’t need to tell you what that means.

- Direct vs Indirect: In SEC form 4, you can see that there is a column to indicate direct or indirect transaction. Don’t just disregard indirect ones as they usually mean a relative of the main guy is trading on insider info, or the insider is buying for his daughter etc.

- Look for batches of insider activity: If CEO, CFO, 4 directors and their mother-in-laws are all buying shares, it means much more than just one officer buying.

Hope this helps. Hit me up on twitter (@codytrades) if you have any questions, comments.

(insidercow.com is my favorite source for tracking insider transactions. Let me know if you want to sign up and I can get you one month free -that gives me a free month as well due to referral. I am otherwise a paid subscriber of theirs and have no additional affiliation)