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The next time you go out to eat, follow
the locals. Why? They usually know the best place!
It can work the same way with stocks:
There are more than 10,000 stocks to choose from in the U.S., and many
are just the equivalent of tourist traps, with sexy sales pitches that
lure hapless investors in. So before you commit your money, consider
getting advice from someone who really knows
something about the stock.
Who knows best? The so-called insiders who run the company. That means
the president, the chief financial officer, the VP of sales and
marketing, and any other executives who know before you do if the
development of a new product is going well, or if earnings will suffer
over the loss of a key supplier.
Of course, CEOs rarely call you when they think it’s a good time to
buy stock in their company. And they certainly won’t tell you if
problems loom and you should sell. But they don’t need to. Thanks to
government regulation — we don’t thank it often, but let’s give credit
where it’s due — directors and officers of a company, as well as major
shareholders, are required to publicly disclose when they commit their
own hard-earned money to buying or selling their own stock.
Following these moves shouldn’t be confused with the illegal form of
insider trading, where the president of a company breaks a fiduciary
trust to tell his brother-in-law about a pending acquisition that will
send the stock soaring. Anyone with private information that can
reasonably be expected to affect a stock price is not allowed to trade
that stock, period. But as long as there is no imminent announcement
and the insider simply thinks the business is going well, he’s free to
buy and sell — and you’re free to track him.
However, following the lead of corporate execs is not foolproof. A
purchase by insiders might just be a show of hubris, and by making the
same move, you could end up buying a dog.
If the logic of tracking the insiders sounds appealing, there are some
things you should know before trying to do it on your own. First, it
isn’t some new investing fad. The Journal of Finance, in the
September 1976 issue, published results of a study showing that
insider buying does indeed tend to precede an increase in the stock
price. From the Journal of Portfolio Management in spring 1983,
we learn that hands-on managers are better indicators than are major
shareholders. But it is important to act fast. A 1993 article in the
Southern Business and Economic Journal revealed that yes,
buying can signal a lasting turnaround, but the greatest gain comes
within the first month after an insider purchase.
Selling can mean insiders think the stock’s about to tank, but it can
be more innocent, too: The insider may just need to raise some quick
cash for a backyard pool or a divorce settlement. Basically, insiders
can have all kinds of reasons to sell, but usually only one reason to
buy:They think the stock will go up.
Now for the bad news: Short of hanging out in the library at
the Securities and Exchange Commission, there is no cheap, efficient
way to get a comprehensive listing of insider trades. So don’t go it
alone. No one is suggesting that tracking insider trades should be
your first and last stop. It makes so much intuitive sense that people
can read too much into it, and it makes the same intuitive sense to
use a lot of different tools. Still, if you’re a novice investor who
has trouble sorting good advice from hype, following the insiders’
lead is a pretty good bet.
Insiders know the direction their company is headed, why not believe
they know the direction their stock is going? The key is knowing
WHO is buying or
selling and WHEN. It's
information that will change the way you
invest from this day
forward. As the saying goes, "If you
think education is expensive, try ignorance."
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