Insider trading has a sinister connotation, and for good reason. Stakeholders who buy and sell stocks based on privileged information are often breaking the law and face stiff penalties. However, in some cases, insider trading, sometimes called inside trading, is legal.
We’ll walk through the insider trading definition and go over certain cases where it’s perfectly acceptable for company insiders to buy and sell their stock. You'll also discover how following legal inside trade transactions can help you make more informed investment decisions.
What is Insider Trading?
What is insider trading, exactly? When someone buys and sells securities based on material, nonpublic information related to the security, it’s insider trading.
Is insider trading illegal? When executives, analysts or large shareholders of the company do it, it’s illegal in most cases because it gives the insider an unfair advantage over the general public.
The Securities and Exchange Commission (SEC) regulates insider trading to prevent unfair advantages and to ensure fair and orderly markets. Insider trading is illegal if the trader has knowledge of the material and nonpublic information about the security. This means that the insider has knowledge of information that could affect the security’s price and the public does not.
Legal insider trading occurs when an insider has access to material nonpublic information but does not use it to gain an advantage in trading. Legal insider trading is regulated by the SEC. You can read our guide on what to know about insider trades for more information.
Understanding Insider Trading
Insider trading can have a significant impact on a company’s stock price. When nonpublic information is leaked and traded illegally, it can cause the stock price to move in a direction not reflective of the company’s true value. This can create an unfair playing field for other investors and can lead to losses for those who are unaware of insider trading. It’s a good idea to know about insider trading and to avoid investing in companies that may engage in it.
Meanwhile, legitimate insider trading can be an invaluable source of information. By tracking insider transactions, you can get a better sense of the direction the company will go and can get an indication of the company's future prospects. You can find companies with high amounts of insiders buying and selling their stocks with our insider trades screener.
Buying and selling shares of stock are important trading signals for investors because it reveals insiders’ confidence in the company’s future. When directors buy shares, it indicates that they are confident that the company is in good shape and that their investments in the company will pay off. When directors sell shares, it indicates that they are not as confident in the company’s prospects and that they may be looking to cash out before the stock price drops.
A chief financial officer (CFO) at the company often has the best estimation of a company's financial health. For this reason, it can be valuable to monitor CFO buys and sells.
Legal Insider Trading
Legal insider stock trading refers to the practice of trading stocks through an insider’s knowledge of a company’s performance. This type of trading is illegal in many countries, as it is seen as a form of insider trading. However, in some countries, such as the United States, it is permissible under certain circumstances.
Here’s an example of legal insider trading: A company executive uses knowledge of the company’s financial performance to purchase stocks in the company. This type of insider trading is legal if reported to the SEC and if the purchase was not made using material nonpublic information.
Illegal Insider Trading
Illegal insider stock trading is a type of securities fraud that occurs when a person uses nonpublic information to make trades in the stock market. This type of fraud involves a person who is in a position of trust and has access to confidential information about a company.
An example of illegal insider stock trading is when a person uses nonpublic information about a company to purchase or sell its stock. For example, if an executive of a company knows that the company will announce a major new product, they may purchase stock in the company before the announcement is made public. This is illegal because the executive uses information not available to the general public and trade on it to benefit themselves.
Another example of illegal insider stock trading is when a person uses information that they gained from another person in a position of trust. For example, if a lawyer is privy to information about a company that is not publically available, such as a potential merger or acquisition, they may use that information to buy or sell stock in the company. This is illegal because the lawyer used information gained through a position of trust and will trade on it for their own benefit.
Insider Trading vs. Insider Information
“Insider trading” and “insider information” describe buying and selling securities by people who have access to information not available to the general public. Insider trading is illegal and can result in criminal penalties, while insider information is legal and can be used to inform investment decisions.
Insider trading is the buying or selling of securities by people who have access to non-public information about the company or security. This type of trading is illegal and can result in criminal prosecution. Examples of insider trading might look like this:
A company executive purchases shares of his own company based on non-public financial information. In another example, a person who receives a tip from a friend in the company about a pending merger buys shares before the public knows about the news.
Insider information refers to information about a company or security that is not available to the public. It includes knowledge of a company’s upcoming earnings report, a pending acquisition or news of a new product launch. You can use this type of information to inform investment decisions, but it is not illegal to possess or use it.
Insider information can be obtained from a variety of sources, including through company executives, financial advisors, industry analysts and news outlets. Remember that insider information is not always accurate and that it should not be used as the sole basis for investing decisions.
In conclusion, insider trading and insider information are related but distinct concepts. Insider trading is illegal and can lead to criminal penalties, while insider information is legal and you can use it to inform investment decisions. It is important to remember that insider information should not be used as the sole basis for investment decisions and that it is not always accurate.
Where to Find Insider Trading Data
The primary source for insider trading data is the U.S. Securities and Exchange Commission (SEC). The SEC requires companies to disclose certain transactions involving securities or derivatives of securities. Companies must file a Form 4 with the SEC whenever an insider makes a transaction, such as buying or selling shares or exercising options. These forms are available on the SEC’s website and can be accessed using the SEC’s EDGAR database.
Investors can also access insider trading data directly from the companies themselves. Companies are required to file an 8-K form with the SEC whenever there is a material change in the company’s operations. These forms often contain information about insider trading transactions. Companies must disclose any stock options granted to executives and other insiders. This information is typically available in the company’s proxy statement, available on the SEC’s EDGAR website.
How to Use Insider Trading Information Legally
While insider trading is generally illegal, there are ways to use insider trading information legally.
First, investors can use public information about insider trading activity to learn more about the company and its stock. For example, investors can watch for large purchases or sales of a company’s stock by its officers or directors. These transactions are reported to the SEC and can be found on the SEC’s EDGAR website. Investors can then use the information to research the company and make informed investment decisions.
Second, investors can create an “insider trading watch list,” where they track specific officers or directors and watch for any unusual trading activity. This can help investors stay up to date on potential major changes that may be taking place within the company.
Third, investors can use their knowledge of insider trading activity to identify potential investment opportunities. For example, if an officer or director of a company has made a large purchase of the company’s stock, it could be a sign that the company is doing well and is a good investment.
Finally, investors can use “insider trading alerts” to help them stay informed about any new insider trading activity. These alerts are available from various sources, including the SEC, and will notify you of any new insider trading activity.
Insider Trading Data Offers a Wealth of Information
While illegal insider trading is severely punished, legal insider traders can send signals to the market about how they feel about the future performance of their company. Now that you know the answer to “What does insider trading mean?” you know that investors who pay attention to these signals may make more informed investment decisions.
Let’s take a look at some frequently asked questions about insider trading.
What are examples of insider trading?
Examples of insider trading include executives trading company securities with the knowledge of quarterly earnings or employees trading based on material nonpublic information they learned while working with the company.
Insider trading is illegal in most countries and can lead to fines, imprisonment or both, depending on the severity of the infraction. Legal insider trading can be done by stakeholders in the company under specific scenarios.
What is the meaning of insider trade?
An insider trade is when a company executive or employee buys or sells stock in the company they work for. This can be both legal and illegal in certain circumstances.
What are the two types of insider trading?
The two types of insider trading include legal insider trading and illegal insider trading. Legal insider trading occurs when corporate insiders, such as executives and directors, use information that is not available to the public to buy and sell stocks, in accordance with legal regulations.
Illegal insider trading occurs when corporate insiders use confidential information to buy or sell stocks in the company for their own personal gain.