Insider trading and Form 4: what it means when an executive buys or sells their company's stock

Nobody knows a company better than the people running it. So when a CEO buys their company's stock with their own money, investors notice. And when they sell, investors worry.

In the US these trades are public, just days after they happen. They are reported on an SEC form called Form 4. The problem is that most transactions on a Form 4 are not what they look like. This article explains who files, how to separate the trades that matter from the rest, and why a purchase usually says much more than a sale.

Who the insiders are

US law defines three groups who must report every trade in the company's stock:

• officers (the CEO, the chief financial officer and the other senior executives),
• directors on the board,
• anyone owning more than 10% of the company's shares.

When someone becomes an insider, they file a Form 3 listing what they own. After that, every change is reported on a Form 4, within two business days of the trade. All of it is public on EDGAR, the SEC's database.

One clarification: "insider trading" means two different things in English. One is illegal: trading on information that has not been made public. The other is perfectly legal: the reported trades of the company's own people. This article is about the second.

Most transactions are not purchases or sales

Every line on a Form 4 carries a transaction code, a letter saying what happened. It is the single most important thing for reading a Form 4 correctly, because most lines are not decisions by the insider to buy or sell.

An example you will see often: an executive exercises options (M), the company withholds some shares for the tax (F), and they sell the rest (S), all on the same day. A hasty reader sees "the executive sold 50,000 shares". In reality they cashed in part of their pay, as they do every year.

Why purchases matter more than sales

An insider sells for many reasons unrelated to where the company is heading: to pay taxes, to buy a house, to avoid having their whole fortune in one stock. Senior executives receive a large part of their pay in stock, so it is natural for them to sell regularly.

A purchase is different. Someone who already has much of their wealth tied up in the company, and puts in more from their own pocket, usually does it for one reason: they believe the stock is worth more than its price. Many academic studies have found that insider purchases were followed, on average, by better returns than insider sales. On average, though, not every time.

Three things make a purchase more meaningful:

• Several at once (cluster buying). When three or four executives buy within the same few weeks, it is much harder to be a coincidence.
• Size relative to the person. A 50,000 dollar purchase by a CEO paid 10 million a year says little. A 2 million purchase says a lot.
• Who is buying. The CEO and the chief financial officer see the numbers first. Their purchases usually count for more than those of an independent director.

When a sale deserves attention

Sales say less, but not nothing. They are worth a look when:

• several insiders sell together, especially outside their usual selling season,
• an insider sells a large share of their holding, not a small slice,
• the sale was not scheduled.

The last point needs explaining. Many insiders sell through a 10b5-1 plan: they decide in advance, while they have no inside information, when or at what price they will sell. Since 2023 the rules are stricter. There is a mandatory waiting period between setting up the plan and the first trade, and Form 4 shows whether a trade was made under such a plan. A sale under a 10b5-1 plan was designed months earlier and says very little about what the insider thinks today. A sale outside a plan says more.

The limits of the signal

Insider trades are useful information, not a guide.

• Insiders get it wrong. They know their company, not where the market or the economy is going. Plenty bought their company's stock shortly before it fell further.
• Some purchases are for show. A small purchase after bad news can be management's way of signalling confidence, more than a real investment.
• Large companies see few purchases. At very large companies executives rarely buy in the open market, because they already receive a lot of stock as pay. The absence of purchases there means nothing.

That is why insider trades are read together with everything else: the company's numbers, its valuation, its risks. A similar signal, with similar limits, is the positions of large institutional investors, explained in the article on 13F filings and smart money.

How to see them

Every Form 4 is free on EDGAR, on each company's page, filtered by form type "4". When reading one, look at the transaction code first and the amount second.

Ploutos analyses read Form 4 filings straight from the SEC and separate the transactions by code, so an option exercise or a tax withholding does not count as a decision to buy or sell. If you want to see how they look for a real company, alongside the rest of its picture, you can run an analysis.