Insider Buys – Day-Trade & Longer-Term Strategy
by Ilene
A generally reliable stock-trading strategy is to buy a stock when an insider has just reported a significant purchase to the SEC.
The theory is simple: the insider knows the stock is undervalued and/or knows there is good news on the way which will move the stock price up, and he believes that this move will be sustainable (because the insider has to hold the shares for at least 6 months to keep a gain).
There are a number of services which will notify subscribers when an insider buys stock. Some services provide notification within minutes. The price of the service often reflects how fast they get the information to subscribers via email alerts. The proprietary software I use to monitor the SEC site also rates the quality of the insider buy using an algorithm (developed by some of my friends) which considered a number of variables (below). If the buy had a high score, it was usually pretty safe to briefly look at the SEC filing and the chart, and if those looked good, go ahead and buy the stock. Then do a little research to make sure you didn’t make a mistake and decide whether to hold the position overnight.
This can work well for both day-trades and longer- term trades. About three or four years ago, this method worked very consistently. Then two changes in the day-trading patterns and the market occurred which reduced its reliability. First, the strategy seemed to suddenly catch on among traders with faster access to the SEC and greater buying power. The result was that the "marginal trades" that may have previously been successful, stopped working. The traders (trading programs?) who had bought earliest, and in large quantities, needed to get out. The quality of the insider buy (e.g., significant buying, good liquidity, optimal market capitalization) became more important. For smaller cap stocks, looking at the charts revealed what was going on. There was often a quick spike minutes before my software program, accessing the SEC site, signaled an insider buy. And then a wall of selling pressure. The stock traded as though a seller (program?) was relentlessly dumping huge quantities into the subsequent move. There were often not enough buyers to get over the wall and the stock would fall back. 
Second, the overall condition of the market deteriorated. Trades based on insider buying – day-trade or longer term – are influenced by tone of the rest of the market, so when the when the broad market’s selling off, being selective becomes especially important.
Variables – factors to consider when deciding whether to buy, how much, and how long to hold:
1. Price – the insider buy price should not be much lower than where the stock is currently trading, e.g., if the insider bought stock for $6, I wouldn’t pay $8, but might pay $6.35. It’s a judgment call, but I think the algorithm uses a specific % rise, over which the score for quality of the trade decreases. A higher % would be warranted if the insider was a CEO or CFO and the dollar amount of the purchase was very large.
2. Liquidity – look at the chart, a lot of choppy stairs on the daily chart is a warning. Example: stock trades less than 60,000 shares a day, and you buy 5,000 shares 10% higher than it was when it first started running before you saw it. Chances are pretty good that the stock will now reverse and start dropping. The guys/program that got to it faster than you are racing to get out with their day-trade profits. By the time you figure this out (having failed to look at the daily chart!), your stock’s down 15% (yes, down more than it was ever up). Getting out with a smallish loss becomes a long-term project and you hope the insider buyer was expecting good news in the immediate future.
3. Dollar value of the purchase – this criterion has become more important in the last few years. It used to be that if an insider/officer bought over $100K of a sufficiently liquid stock, there was a good chance the stock would hold up and be up again the next day. This doesn’t seem true anymore and I’d move the threshold for amount of purchase up to around $200K. I’m less likely to hold overnight too. A few years ago, holding the stock for four days gave the greatest average short-term gain. This probably isn’t true anymore.
4. Market Cap – over $100-$200 million to $1 billion is around the optimal range. Too small leads to liquidity issues. Too large results in a negligible effect on the stock price.
5. Buyer’s Identity – CEO and CFO are best, other officers next, then directors, then 10% owners (which did not typically move stocks).
6. Sector – some sectors are better than others. Companies in the technology sector were the best movers. Energy stocks didn’t used to be, but may be now.
7. Number of shares. Strangely, this was an independent variable which had a significant effect on post-buy stock performance. Intuitively, it would seem to be a reflection of purchase amount and market cap. Perhaps, the independent significance of number of shares reflected the influence of traders who would only buy if the number of shares purchased was as at least 3,000. I’m not sure if this is still an independent variable.
8. Market Conditions – if the market is weak, as it’s been for most of this year, the insider buy has to be more meaningful to generate a highly reliable trade. For instance, I like to see a large purchase amount, a CEO or CFO buying, and market cap and liquidity within optimal ranges. 
Most of the potential insider-buy trades in a weak market are unpredicatable. However, if an officer is buying a substantial amount of stock (e.g. million dollars worth), these trades are usually fairly safe. The reason is probably that in a bad market, everyone else trading this strategy is also more selective and less inclined to hold a position for long, making the duration of the trade shorter and holding more dangerous. However, if the insider buy is large enough, there’s an effect beyond the momentum of day-trading — the buy was signficant and the insider is confident the stock is underpriced and will eventually go up, regardless of the immediate move due to day-traders.
If you have any comments or questions, my email address is ilene@philstockworld.com, or use the comment section after I import this post to the backup site. – Ilene
