Another Take on Insider Trading

(MoneyWatch)  Last Friday, I wrote a response to a CNNMoney.com article that suggested it may be time to sell stocks since corporate insiders are selling their shares. David Ressner, my colleague at Buckingham Asset Management, wrote a response as well, and I thought it provided some great additional insight.

Steve Forbes quotes his grandfather as saying, "You make more money selling the advice than following it."

In other words, if data providers such as Trim Tabs and InsiderScore.com truly thought you could capitalize on their research, why would they share it with the public? They'd be better off keeping the information to themselves. Obviously, they must agree with the premise behind Forbes' quote.

It's possible that these companies may be trying to gain the best of both worlds -- following their own advice for investing, then selling it as well for additional revenue. However, by selling their info, they would be diluting any value their information has. That's the beauty of the Efficient Market Hypothesis -- if an anomaly is discovered, the race to profit from it will cause the anomaly to disappear.

Another interesting note from the CNNMoney.com article is the quote offered by Charles Biderman, who runs Trim Tabs. He said "It's not a very complicated story. Insiders know better than you and me. If prices are too high, they sell."

In March 2007, Biderman was seeing the opposite occurring: Corporate insiders were buying instead of selling. This caused Biderman to be enthusiastic about investing in the U.S. stock market. "We are as bullish as ever on the U.S. stock market because the smartest money in it -- the top insiders who run public companies -- are signaling through their actions that U.S. equities are a screaming buy."

He went on to say, "We admit we have no way to predict enormous one-day sell-offs... Our methodology is designed to predict the direction of the stock market over weeks and months, not days." Not long after, the S&P 500 Index would hit its peak around 1550 and fluctuate for a few months, briefly touching the same level in October before the market began its descent.

Time will tell if Biderman's current call is right, but even if he is, selling all or most of one's equities now is not the right strategy. The right strategy is choosing and adhering to an asset allocation you can live with through good times and bad.