Investors are constantly searching for signals that can help them identify winning stocks before the broader market catches on. One of the most closely watched indicators is insider trading activity—the legal buying and selling of company stock by executives, directors, and other insiders who have unique insight into their businesses.
However, not all insider transactions are created equal. While both insider buying and insider selling receive attention from investors, decades of academic research suggest that insider buying is far more meaningful. In fact, studies have repeatedly found that portfolios built around insider purchases have outperformed the market over time, while insider sales have proven to be much less meaningful.
In other words, while buying by company insiders can help you outperform the market, selling by insiders is better off ignored.
The Case for Following Insider Buying
Corporate insiders generally know more about their companies than outside investors. They have firsthand visibility into customer demand, product pipelines, operational trends, hiring plans, and strategic initiatives. While insider trading laws prohibit executives from trading on material nonpublic information, insiders still possess a deeper understanding of their businesses than virtually anyone else.
When executives spend a sizable amount of their own money to buy shares in the open market, they are making a statement, effectively saying, “Based on everything I know about this company, I believe the stock is undervalued.”
Academic research suggests that this signal has real predictive value.
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One of the most influential studies on the topic, “Are Insiders’ Trades Informative?”, conducted by Josef Lakonishok and Inmoo Lee, examined insider transactions across U.S. markets from 1975 through 1995. The researchers found that insiders “predict market movements better than simple contrarian strategies,” meaning that bullish activity by insiders tended to precede bullish market movement.
They also found that the predictive power was especially strong among smaller companies, which tend to be less widely followed, with less information available for investors.
Another widely cited study, “Estimating the Returns to Insider Trading: A Performance-Evaluation Perspective,” by Jeng, Metrick, and Zeckhauser, found that portfolios built around insider purchases generated “abnormal returns” (outperformance) exceeding six percentage points annually. Interestingly, the researchers concluded that insider sales offered little predictive value by comparison.
Taken together, these studies suggest that insider buying can be a useful indicator of future stock performance.
Why Insider Selling Is Different
If insider buying is bullish, shouldn’t insider selling be bearish?
Not necessarily.
The problem is that insiders buy for one main reason, but sell for countless reasons.
When an executive buys stock on the open market, the motivation is usually straightforward: they believe the shares will appreciate. Unlike stock grants or option exercises, open-market purchases require an insider to commit personal capital and take on additional financial risk.
Selling, on the other hand, is much more ambiguous.
Executives frequently sell shares for reasons that have nothing to do with their outlook on the business. Common reasons include:
- Diversifying a concentrated personal portfolio
- Paying taxes on stock compensation
- Funding a home purchase or other major expense
- Estate planning
- Charitable giving
- Liquidity needs
In many cases, insiders already have a substantial portion of their net worth tied to the company. Selling shares can simply be prudent financial planning rather than a signal that trouble lies ahead.
This helps explain why academic studies consistently find stronger predictive power in insider purchases than insider sales.
In the words of Lakonishok and Lee, “Insiders have many reasons to sell shares but the main reason to buy shares is to make money. Our results support this view. Only insider purchases appear to be useful, while sales are not associated with low returns.”
Looking Beyond Individual Transactions
While insider buying can be valuable, it’s not a guarantee of outperformance.
The most informative insider purchases tend to share several characteristics, something that Michael Brush, Chief Analyst of Cabot Insider Edge, calls “signal enhancers.” He’s written about two of them in the pages of the Cabot Wealth Daily before:
Large Purchases
A $10,000 purchase from a highly compensated CEO may not mean much. A $1 million purchase funded with personal cash sends a stronger message.
Cluster Buying
When multiple executives and directors buy shares around the same time, the signal becomes more compelling. Cluster buying suggests that confidence is shared across the leadership team rather than being limited to a single individual. Research has found that coordinated insider buying tends to generate stronger subsequent returns than isolated purchases.
The Insider Edge
Insider activity remains one of the few market signals backed by decades of academic evidence. While no indicator is perfect, research consistently shows that insider buying has predictive value and can help identify stocks with above-average return potential.
The key insight is that insider buying and insider selling should not be treated as mirror images of one another.
Buying requires insiders to commit their own capital because they believe the opportunity is attractive. Selling, by contrast, may reflect nothing more than diversification, tax planning, or personal financial needs.
For investors analyzing insider activity, the most useful question is often not, “Why are they selling?” but rather, “Why are they buying?”
And if you’re interested in adding insider activity to your own portfolio strategy, subscribe to Cabot Insider Edge, where Chief Analyst Michael Brush uses a combination of insider activity, fundamental analysis, and his own signal enhancers to identify promising opportunities, often when a firm is underloved and ready for a fresh, sustained uptrend.
We have a special offer available for new subscribers.
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