Insider Update

02/09/04 09:01:53 AM

by Matt Blackman

Insiders continue to unload in January.

Security: NA
Position: N/A

Insiders continued to sell their company's stock at high levels in January. According to a February 4 client advisory by Thomson Financial, insiders sold $3 billion worth of stock, the second highest January level behind 2001 ($3.2 billion) and the sixth consecutive month to exceed the historic five-year monthly average of $2.7 billion.

Meanwhile, insider buying declined 42% from December '03 to $71 million worth of stock in January. The advisory commented that the last time January insider buying levels were this anemic was in 1995 when executives purchased just $54 million worth of their own company's stock.

Figure 1 � Chart of the monthly insider sell/buy ratio of insider transaction activity between November 02 and January 04. Data by http://www.thomsonfinancial.com

The insider sell/buy ratio, a very useful metric in gauging and comparing insider activity over time was $42.33 in January, up from $27.86 in December and down slightly from the November ratio of $42.98.

It hit a high of $50.44 in October '03, the second highest monthly number since records have been kept, behind February 1991 when insiders sold $54.87 worth of shares for every dollar purchased. This was also the first year of a bull market. Selling short based solely on the fact that the ratio was then at an extreme would have been a bad idea. The S&P 500 jumped from 365 at the end of February to 390 in May 1991. However, by year-end, the index was still only trading at 385. Similar losses would have been incurred by selling short when the ratio hit a selling extreme in Oct '03.

Experts who have followed insider transactions agree that insider buying is a better indicator to follow than insider selling. Insiders sell for a variety of reasons and are often just taking a paycheck or cashing in on recent strength. However, when they buy, they are trading their hard earned money for stock because they believe it is cheap.

A study of monthly insider data from 1990 through 2003 revealed that following insider buying during the bull market from 1990 to 1999 would have been a profitable strategy. However, buying with insiders would have not been as profitable (using monthly data signals) during the bear market (2000-2002). Selling at insider selling extremes during this period, on the other hand, would have been a good tactic, demonstrating the merit of the sage advice: it is best to execute trading signals in the direction of the predominant trend.

The moral is that as long as the bull market continues, buying when insiders do works well but when the market begins to turn, insiders have proven that they are usually the first ones headed for the exits and they like to get there good and early. Final proof that a turn has occurred will come in the form of a significant break in trend and penetration of key support levels.

SUGGESTED READING:

Blackman, Matt [2004] Insider Year-End Wrap (http://technical.traders.com/tradersonline/display.asp?art=1450) Jan 6

Matt Blackman

Matt Blackman is a full-time technical and financial writer and trader. He produces corporate and financial newsletters, and assists clients in getting published in the mainstream media. He is the host of TradeSystemGuru.com. Matt has earned the Chartered Market Technician (CMT) designation. Find out what stocks and futures Matt is watching on Twitter at www.twitter.com/RatioTrade

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