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Wednesday, October 23, 2013 - 14:30

Make Insider Trading Work For You -- Without Going To Jail

Wednesday, October 23, 2013 2:30 PM

Billionaires go to jail for it. Money managers have fled the country and faked suicides when it's suggested. Hedge funds have paid billions in fines and been harassed by the Securities and Exchange Commission (SEC) on little more than a hint of its occurrence.

Mark Cuban
Flickr/DannyB
Celebrity investor and high-tech titan Mark Cuban recently fought and secured a courtroom victory after being accused of violating insider trading laws.

Most recently, celebrity investor and high-tech titan Mark Cuban fought and secured a courtroom victory when accused of violating this regulation. Famed entrepreneur and TV personality Martha Stewart wasn't as fortunate as Cuban -- she spent time behind bars in 2004 for what amounted to be a relatively small amount of money.

The strangest thing is, this action is considered a legitimate edge in the commodity markets. It's only in the stock market where it's considered a mortal sin.

If you haven't guessed, I am talking about insider trading.

Insider trading offers an unfair advantage to those with the information and capacity to profit from it. It is the desire to level the playing field that motivates the authorities to clamp down on insider trading. It truly is the most powerful edge available in the stock market, hence its illegal status.

While non-public insider trading is illegal, there is a way to capture some of this edge for yourself without worrying about SEC wiretaps and a guilty conscience.

Company insiders are required by law to make their stock transactions public. This information is readily available online. There are several websites that compile this information, but my favorite (and one of the most widely used) is Yahoo Finance.

To find this information, first plug in the stock symbol on the Yahoo Finance's ticker lookup field. When the company's information page has loaded, find the "Ownership" section near the bottom of the blue rail on the left side of the page. Here you will find the major holders, insider transactions and the insider roster. The insider transaction section will show insiders who are selling and/or buying shares. Look for a substantial tilt on the buy or sell side by insiders to gain an overall perspective.

Remember, insiders can sell shares for any reason. However, large relative amounts, a sudden shift from a being a consistent buyer to a seller or vice versa, or a preponderance of buyers/sellers can signal something is going on that has not yet made the news.

In my experience, insider purchases are more telling than insider sales. In general, one only purchases with the desire to make a profit. Selling can be a signal of bad news around the corner or it can simply be a monetary need of the seller. It's not possible to tell the difference on an individual basis.

It is this insider information that can tip off investors to pending trouble or bullish stock news. For those interested in more detailed information on insider activity, InsiderInsights.com is the website I find most helpful, and Morningstar.com has a very thorough section on current insider transactions.

The following are three stocks that appear to be sending signals of insider activity.

1. Home Depot (NYSE: HD)​
Director Mark Vadon recently purchased 10,000 shares for $752,000. This is on top of a 5,000-share purchase last December for $318,500. He paid $63.70 per share last December compared with $75.20 in September. I see this as a serious vote of bullish confidence.​

2. Illinois Tool Works (NYSE: ITW)​
Chief Financial Officer Michael Larson doubled his holdings of ITW with his September purchase of 7,000 shares at $74.25. After the transaction, Illinois Tool Works missed third-quarter earnings estimates. Shares dipped, but then took off again on the upside to a recent $78. The company is spinning off its industrial packaging division, which should continue to have a bullish effect, in addition to a share buyback plan that could push shares higher.​

3. Synageva BioPharma (Nasdaq: GEVA)​
Chairman Felix Baker recently purchased more than 1 million shares at $56.63 apiece. He currently holds 7.8 million shares of GEVA. Synageva has a substantial pipeline of treatments for rare diseases, with a treatment for lysosomal acid lipase (LAL) deficiency being the lead candidate.​

Risks to Consider: Insider activity is not necessarily a sign of pending price changes in a stock. It should be considered another tool in your investment toolbox, not the end-all for decision making. Always use stop-loss orders, diversification and position size properly regardless of insider activity.

Action to Take --> Be aware the insider activity on every stock in your portfolio and start this discipline on every new stock you consider buying. Insider activity can signal substantial pending price changes and help you figure out which holdings to keep a closer eye on.

P.S. Wouldn't it be great to get an edge in the market without the risk of illegal insider trading? We've recently identified more of the market's most dominant companies in our latest report, "The Top 10 Stocks For 2014." One stock has raised its dividend 36 times since 2004, while another has boosted its dividend a whopping 183% since 2011. These 10 stocks have nearly tripled the market's return, delivering an average gain of 129.5% over the past five years. To get more information, click here.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.