There are 2 general ways to outperform buy and hold in the stock market:
- Time the broad “stock market” (e.g. be fairly accurate at predicting corrections and bear markets)
- Buy stocks that are better than the broad stock market
Today I will show you how insider trading data can help you improve your trading performance by buying stocks that are better than the broad stock market (S&P 500). Corporate insiders (e.g. CEOs, CFOs) are smart money. No one understands their company’s prospects better than corporate insiders.
How useful is insider trading data?
Factually speaking, just how useful is insider trading data? How much alpha can insider trading data add to your trading performance?
The following chart illustrates how much corporate insiders beat the S&P 500:
- We took all insider buy transactions for companies that are in the S&P 500. The data comes from our website.
- For every BUY transaction, we calculated how much that trade beat “buy and hold the S&P 500” over the next 3 months. E.g. if Apple’s CEO bought Apple, and Apple went up 10% over the next 3 months while the S&P went up 6%, “alpha” = 4%.
- On every single day, we calculated an average alpha for all the BUY transactions on that date. E.g. if on September 5, 2020 there were 4 buy transactions (alpha of +5%, -1%, +3%, +1%), “average alpha” = 2%
Essentially, “average alpha” shows you how much you will beat the S&P 500 (3 months later) if you buy the stocks that corporate insiders buy instead of buying an S&P 500 ETF like SPY.
This data can be noisy, so we displayed a 3 month average of this “average alpha”.
From 2003-present, the average day saw insider BUY transactions beat the S&P 500 by 3.3% over the next 3 months!
On an annualized basis, if you bought the stocks that corporate insiders bought instead of buying the S&P 500, you would have beaten the S&P 500 by an average of 12%+ per year! This more than doubles the S&P 500’s performance from 2003-present!
Breaking down insiders’ outperformance
There are a few important things to know if you want to use insider data in your own trading:
#1 Insiders are very good buyers at the start of bull markets.
The following chart illustrates periods when insiders significantly beat the S&P 500 (in green) vs. periods when insiders significantly lagged the S&P 500 (in red):
Insiders significantly outperformed the S&P during the 2 fiercest crashes in recent market history: 2008 and March 2020. Why?
Big market crashes usually occur around economic recessions and global disasters. In a recession and market crash, most investors and traders react emotionally and sell indiscriminately. Their “GET ME OUT OF EVERYTHING!!!” mentality depresses companies that are fundamentally weak AND companies that are fundamentally strong.
In the post-crash rally, companies that are fundamentally strong outperform companies that are fundamentally weak. The negative macro environment may even force companies that are fundamentally weak to go bankrupt!
So if a trader is able to only buy the stocks that are fundamentally strong, he/she will outperform the S&P 500.
Once again, no one understands their company’s prospects better than company insiders. These insiders have the most up-to-date information in a rapidly changing environment, allowing them to react more quickly and accurately than the average trader.
That’s why it’s highly profitable to follow corporate insiders’ trades during and after market crashes.
Moreover, insider buying SPIKES in major market crashes. So not only are corporate insiders decent at timing major market bottoms, the specific stocks they buy (their own stocks) outperform the broad stock market in the ensuing rally.
#2 Beware of energy stocks
Corporate insiders on average significantly underperformed the broad stock market in 2015 and early-2020. Why?
Many corporate insiders in energy companies were buying their own stocks in 2015 and February 2020. They bought because they thought their stocks were “cheap”. They could not foresee that oil and energy prices would fall even further, thereby making their “cheap” stocks even cheaper.
In general, no one knows their companies’ prospects better than insiders. HOWEVER, in industries that are heavily impacted by factors out of your control (e.g. oil executives can do nothing nor predict a mega-crash in oil), it’s best to ignore those insider buy transactions.
#3 Insider buy transactions occur more in smaller, non-tech stocks
Broad stock market indices like the S&P 500 are market-cap weighted. This means that a few large companies like Facebook, Apple, Amazon, Microsoft have a huge impact on the broad index.
If we take an average of all insider transactions across S&P 500 companies, that is akin to using an equal-weighted market cap approach.
More importantly, insiders tend to buy more stocks in some industries and buy less in other industries. For example, most tech industry executives do not buy their stocks. Perhaps this is because tech executives are routinely granted millions of dollars in stock options.
You can see this in the insider alpha chart:
The average insider buy transaction didn’t significantly outperform the S&P 500 from 2016-2019. This is different from pre-2015, when insiders routinely outperformed the S&P 500. What changed?
2017-2019 saw tech stocks dramatically outperform the S&P 500. As I just mentioned, tech insiders don’t usually buy their own stocks. Despite this handicap (lack of tech representation in insider trading data), insider trading data at least matched the S&P 500’s gains during those years.
We use insider trading data in our own trading and expect it to generate consistent alpha in the coming years. The next 5 years will likely be a choppy period for markets, which makes it even more important to buy fundamentally sound stocks and sell fundamentally weak stocks. Insiders can help us identify strong vs. weak.
How to increase your profits even further with insider data
We already display insider trading data on our website. In the next few weeks we will make this data even more useful by:
- Adding sector & industry filters. This will allow us to filter out transactions that we want to ignore, e.g. ignore insider transactions from energy companies.
- Adding growth screeners. This will allow us to only look at high growth stocks that insiders are buying.
Most importantly, we will be ranking insider transactions based on how important the transactions are. While insider trading data is useful, traders like you and I shouldn’t follow every trade. We should only follow a subset of very meaningful trades.
Here are some examples of insider transactions that are more worthy of attention:
- Transactions from CEOs are more important than transactions from lower-ranking executives.
- Large $ size transactions are more important than small $ size transactions.
- Non-planned transactions are more important than pre-planned transactions.
In essence, this Ranking System separates the signal from the noise. It separates trades where e.g. a CEO is selling stock because he wants to buy a house (not a valid reason to follow this transaction) vs. trades were the CEO truly knows something about the company that the average Joe doesn’t know (a valid reason to follow this transaction).
If you have any questions, please email me at firstname.lastname@example.org or leave a comment below.