Individual Investors Follow Opportunistic Inside Traders

When insiders buy opportunistically, individual investors tend to follow.

By looking at trading patterns following insider opportunistic purchases, researchers found that individual investors tend to trade alongside insiders. An opportunistic insider is one who has traded for at least three years in the past, but does not have an obvious discernible pattern to their trades.

Opportunistic insider purchases are followed regardless of the level of investor attention, earnings announcements or changes in analyst ratings. These results demonstrate that individual investors follow insider trades due to the “private information content revealed by these trades,” rather than the information they share with insiders.

With technological advances and more readily available information, individuals are able to research insider trades on their own. Many individual investors use the U.S. Securities and Exchange Commission’s (SEC) EDGAR database to collect information about insider trades, which directly influences their decisions. Researchers found that downloads of SEC insider trading filing Form 4 in the EDGAR database have increased among individual investors. Further, the authors said that “retail purchases are also higher with higher abnormal Form 4 downloads by individual investors.”

Individual investors tend to follow insider opportunistic purchases rather than uninformed routine buys (a trade place in the same month for at least three years). On the other hand, the trading patterns of individual investors did not reveal any clear distinctions between opportunistic and routine sale conditions.

Higher cumulative abnormal returns were observed for stocks that individual investors bought compared to ones they sold, with significant positive returns lasting for up to 18 weeks. In addition, no evidence of long-term return reversals was found.

Researchers also found that return predictability mainly comes from the information that individual investors gather from insider trades, rather than liquidity provision (more shares being traded) or temporary price pressure. In addition, this effect is “stronger for stocks with greater informational uncertainty and higher arbitrage costs.”

The return differences between stocks bought and sold by individual investors are substantially higher for smaller stocks, stocks with higher idiosyncratic (stock-specific) volatility and stocks with higher illiquidity.

The study’s authors conclude that the overall results demonstrate that “retail trading helps improve price efficiency by impounding information revealed from insider trading into stock prices.”

Source: “Can Retail Investors Learn From Insiders?” by Ekkehart Boehmer, Bo Sang and Zhe Zhang, April 2021.