Keeping tabs on insider trading activity is a great way to avoid locking in losses. That’s because when you look at the total stock market, you’ll see that corporate insiders — the executives and directors who know more about their company’s prospects than you — don’t sell low.
Interestingly, insider trading appears to be a good short-term indicator, too.
Insiders always sell more stock than they buy. After all, they get most of their shares in the form of options, warrants and straight-up stock as part of their compensation packages. But it turns out that the ratio of insider selling to insider buying appears to correlate closely with short-term market swings, notes Beating Buffett, a value investing website.
Looking at the overall market, when insiders sell $12 of stock for every $1 they buy — a ratio of 12:1 — or less, that’s a bullish indicator for the S&P 500. When the ratio jumps to 20:1 or greater, that’s a bearish indicator.
Have a look at this chart courtesy of Beating Buffett, which compares the ratio of insider selling to buying with the SPDR S&P 500 ETF (NYSE:SPY) over the last year:
We’re only about halfway through June, but the current sell-to-buy ratio stands at just 8.25, according to Thomson Reuters Stock Reports, meaning insiders are selling $8.25 worth of stock for every $1 they’re buying. That’s the lowest level since September 2011, when the ratio hit 5.98. By Beating Buffett’s reckoning, the market is set for more short-term gains.
Taking another view, it’s abundantly clear that if you look at the sell-to-buy ratio, insiders just don’t sell low. They hold onto their shares when the market is tanking, and sell like mad when stocks are rising.
Have a look at this one-year chart of the overall market’s sell-to-buy ratio, courtesy of Thomson Reuters Stock Reports:
Last summer’s market rout saw the S&P 500 close below 1,150 nine times in August and September. Stocks didn’t sound a bottom until Sept. 30, when the S&P closed at 1,099, off 13.6% for the year to date. The chart shows that during those same two months, the insider sell-to-buy ratio also bottomed out.
Now, have a look at when the ratio peaked, and you’ll notice that insiders do what all investors are supposed to do: They sell high. During the past year, the sell-to-buy ratio peaked in February and March when the S&P 500 was on its way up to above 1,400, good for a 13% year-to-date gain at that point.
Insiders don’t sell low for a bunch of reasons. (That you can’t make money exercising underwater options is a biggie.) But they also know that panicking when the market is tanking is a great way to lock in losses. Retail investors would be wise to remember that the next time stocks plunge.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.