Don't Buy What Insiders Are Selling

 | May 29, 2014 | 3:00 PM EDT
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If you are going to be long a stock, you might as well buy shares of companies where the people running it are excited enough to open up their wallets and buy stock in the open market. Historically, stocks with insider buying have outperformed the market by a pretty wide margin. Limiting your activity to these stocks instead of the popular hit stocks of the day can help you tip the odds of success in your favor.

The reverse is also true. As far back as the late 1960s, Victor Niederhoffer and Jim Lorie found that when there was cluster selling by top executives and officers of a company, the stock tended to fall in the months ahead. This has been tested many times and confirmed in practice since then. When three or more insiders sell stocks within a month or so, the stock is probably going to move lower.

So those who are looking to make bets against the market should actively seek out stocks with cluster selling. Longer-term investors should join the insiders and sell portfolio holdings when there is aggressive selling.

Electronic Arts (EA) has seen its stock price move higher following a better-than-expected earnings report earlier this month. Management also raised their guidance for the year ahead. Wall Street has jumped all over the stock, pushing the price higher by 23% in the past month.

As bullish as the insiders may sound right now, they apparently think the stock is ahead of itself after the surge. Five of them have been selling stock in the open market this month. All together, they have sold more than $12 million worth of stock. It is highly unlikely that all five of them engaged in estate planning or had a sudden one-time need for cash, so you have to assume that the people running Electronic Arts think the stock price is just too high given the company's outlook for the months ahead.

Marriott (MAR) is one of the best hotel brands in the world. The company has seen business conditions improve dramatically over the past several years. Business travel has picked back up and Marriott reported strong earnings for the first quarter of the year. Business is pretty good but you can overpay for the best businesses and insiders at the hotel giant seem to think the stock is a bit pricey right now. Four insiders, including members of the Marriott family, have sold more than $9.8 million of stock in the past month. If the people running the firm think it is time to trim their positions, investors should probably consider doing the same.

Pioneer Natural Resources (PXD) had a great first quarter and surpassed analyst expectations by a wide margin. The company has benefited from higher production and higher realized prices for its oil and gas. While business has been good, insiders seem to think that the stock price reflects the progress and then some. Five insiders, including CEO Scott Sheffield, have sold a little over $5 million worth of their shares in May. The stock is not cheap -- it trades at almost 30x estimated 2014 profits -- and some of the people running the company think it is a good time to take profits.

Boston Properties (BXP) has had a good run, as real estate values have improved and money has flowed into real estate investment trusts (REITs) over the past couple of years. While the company has an impressive collection of office properties in some strong markets, the shares can hardly be called a bargain as they are trading at more than 3x book value. Some of the people running Boston Properties seem to think their real estate collection is a little pricey at current levels -- four officers and directors have sold more than $4.5 million worth of the stock this month.

An isolated sale of stock by a corporate insider may not have a lot of meaning. When you have a cluster of insider selling, this is not necessarily the case. If several of the people running a particular company are selling shares of their own stock, I don't see a reason to buy what they are selling. If I am a trader, my list of potential short setups is going to be stocks with insider cluster selling.

Insider activity contains valuable information for both investors and traders. You should be checking the data frequently no matter what your timeframe or approach to making money in the stock market.

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