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Investor Psychology

Follow the Inside Track?

When company executives buy or sell their own stock, should you do the same?

When company executives buy or sell their own stock, is that a signal for you to do the same? The short answer: maybe. In some respects, insider activity works like a traffic light. Insiders snapping up their own stock can be a green light, signaling a safe road ahead. Heavy selling can be a sign that something bad is brewing.

Insider buying and selling (not to be confused with illegal insider trading, or trading on privileged corporate information not available to the public) has the potential to sway traders on Main Street as much as it does on Wall Street. But be careful. Insider activity can also be a red herring.

Reading the signs

Recently enacted disclosure regulations have created more accessible and accurate information for individual investors than ever before. The deadline on reporting insider buys has gone from 40 days to 48 hours, says Dan Michaelis of the Securities Industry Association. "The resources are available -- make use of them," he says.

How? Find out what those in the corporate know are doing by visiting Yahoo! Finance. Enter the stock symbol and select "Insider Transactions" on the left-hand side under the "Ownership" heading. You'll see a chart that displays the officer's name and how many shares he or she either bought or sold, when the transaction took place and how much it was worth.

But recognize, first of all, that insider selling isn't going to tell you much. For one thing, executives often exercise their stock options and then sell immediately -- perhaps to raise money for a new house or their kids' next tuition payment at Stanford.

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The problem with trying to read insider selling, says Gerald Perritt, manager of Perritt Microcap Opportunities fund, is that there are more reasons to sell than there are to buy and they don't necessarily represent where the insider thinks the company is headed.

On the other hand, a string of insider buys can be an encouraging sign, so long as it's kept in perspective. Corporate officers who buy stock in their own company (on the open market rather than by exercising stock options) are telling you two things: One, they have confidence in their business, and two, they view their stock as a bargain and expect it to appreciate.

You can glean some predictive power by following insider buys, says Perritt, but you're not going to get rich from it. Perritt points to a study done by Ohio State University in the 1960s that found that stocks of companies where insiders were buying outperformed randomly chosen stocks by about 1% to 3% annually. Not much to get excited about.

Fate of the lemmings

Basing your trading decisions solely on the moves of insiders can be dangerous, says Jim Margard, a stock strategist for the Rainier Funds. "It's more of an art than a science, he says, "and you can easily draw conclusions without enough evidence." For example, insiders may be selling steadily, even as a stock continues to rise. If individual investors follow the insiders' lead, says Margard, they could miss out on some nice gains.

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Nor does a spate of insider buys makes a stock a sure thing. "Corporate officers tend to be optimistic," Perritt says. "After all, they've already hung their career on the company simply by working there." Sure, they expect the company to do well -- but they can be wrong.

Market analysts seem to agree that you're best served by looking at insider activity as a way to back up other research you've done on a stock and see if it confirms your conclusion. "If I notice heavy insider selling on a stock, I might get suspicious," says Margard. "But mostly I keep insider activity in the margins."

The bottom line is to consider what execs do in conjunction with all the other things about a company, including its fundamentals, earnings, future prospects and valuations. If you're sitting on the fence and you see a lot of buys, it might be the thing that pushes you to buy, too.