Trade Like an Insider by Ivan Cavric

Granted legal insider trading may not be as profitable as illegal insider trading, but it will keep you out of jail and enable you to enjoy the benefits of your profits. Company insiders are required to report any trades made in their company to the SEC within 2 business days of the trade. This is information is available to the public through various internet sites. The trick is to sift through the enormous amount of data to select a company that has the most potential to make you money. Easier said than done! Well in fact it is actually quite simple and it doesn’t take up too much of your time.

In order to simplify the search, a few parameters have to be set before you consider an investment. Once you have this in place you will be amazed at how quickly you will identify a potential investment and eliminate numerous others. There are five main points that have to be met before you consider the company for investment purposes. Once you have chosen your stock then we will use a money management technique to maximize profits and minimize losses. More on the money management part later after we’ve discussed the five points that comprise our search criteria.

After you selected a free insider trading report site your first criteria is to consider only BUYS. There is a good reason for this. People sell shares for various reasons such as college tuition for the kids, divorce, vacation, buying a house and many others. However there is only one reason people buy shares and that is to invest and make a profit. Since it is our intention to make a profit we will only consider the recent INSIDER BUYS, those made within the past 2 weeks.

The second point to consider is only BUYS made by senior officers such as CEO, CFO, EVP etc.

Directors and owners have a different agenda sometimes for buying shares whereas the senior officers are employees of the company and are close to day to day operations. They are the ones on the front line, they generally have a feel as to how the business is doing. The lower their rank, the lower their pay scale, hence all the more significant is their purchase of shares.

Third, and this is subjective, however for our purposes we will use a general rule of thumb. Only consider purchases that appear to be an investment and represent investment dollars.

Purchase of 30 shares at $9.00 is not what we would call a significant investment, or for that fact a serious one, especially for a senior officer. However, a purchase of 1500 shares at $9.00 made by the same officer carries more weight and considers our attention. As a rule of thumb the investment should be over $10,000 and be at least a reasonable number of shares.

Fourth, only consider company’s whose shares trade over $5.00 per share and are on a major exchange. Stay away from penny stocks. A definition of a penny stock is any stock whose shares trade below $5.00 per share. There are times when large companies will fall below $5.00 per share but they are still on a major exchange and usually the circumstances are extraordinary. It is best to wait till they are back over $5.00 before considering an investment.

Last but least is to only consider those company’s whose shares are trading near where the insiders made their purchase. If the insiders bought shares substantially lower than the current market price then the stock should be eliminated from the list. Once again this is subjective but 50 percent below the current market price would be considered as substantially lower. On the other hand 15 percent to 20 percent is tolerable. You are looking for value, so be patient.

Once you have finished with the fifth and final step you should have two or three good potential candidates to consider for investment purposes. While this is not part of our main criteria to narrow the field and choose the best investment you need to consider liquidity. If you have two or three to chose from pick the stock with the highest daily volume average. Daily volume is a measure of liquidity and the more liquid a stock is the easier it will be to purchase and sell.

Now that you have your pick don’t rush out yet and make that investment. Remember we were going to implement a money management system. This is a good idea no matter what system you are using for choosing your investments. The money management technique is simple by effective. For demonstration purposes I will use a fictional company, symbol ABC trading at $9 per share. An Executive Vice President of Marketing purchased 2,000 shares at $8.15 four days ago. We are willing to invest $9,000 by purchasing 1,000 shares. However, rather than buying it all at once we divide our investment into three tranches of $3.000 each.

An initial investment is made by purchasing 333 shares at $9 per share for a total of $2997.00 before commissions. Immediately a stop loss is placed at 15 percent below the purchase price or $7.65. A stop loss is where you will get out should the price of the stock drop. At the same time you will make another purchase if the price of the stock drops to $8.10 per share or 10 percent below the initial purchase price. At this time you will purchase 370 shares at $8.10 for a total of $2997.00. Now you have a total of $5994.00 invested and 703 shares at an average price of $8.52. Move your stop loss to $7.24 and make another purchase should the share price drop by 10 percent from your average cost of $8.52 which is $7.66. The trade keeps going against us and drops to $7.66 at which point we invest our last tranche and purchase 391 shares for a total cost of $2995.00.

As you can see you have a total of $8989.00 invested and own 1094 shares at an average cost of $8.21. Now you place a final stop loss at 15 percent below $8.21 or $6.98. At this point should the stock trade this low your position will be liquidated and you will be out of the market. Do not enter again. You have suffered a 15 percent loss but still have sufficient capital to invest elsewhere. On the other hand if the price of the stock never gets near your stop loss but keeps rising follow it weekly with a trailing 15 percent stop loss from the high of the week.

This simple method allows you to maximize profits and limit your losses. It prevents you from falling in love with a company and leaves little room for second guessing. It allows for timing since stocks have a tendency to go down after you make an initial purchase and it preserves you capital. In short it’s a great tool.

One final note, for insider trading reports do a search for free insider trading reports and go to the most comprehensive and easy to use site. You will be surprised how quickly you will find a user friendly site.

Ivan Cavric is the president and managing director of PrimeQuest Capital Corp. Mr. Cavric is also managing consultant of Associated Financial Corp. For over 20 years Mr. Cavric has been involved with venture capital and start up companies. During this period Mr. Cavric has been on advisory boards of several public, private and start up companies providing management services and personnel.