Detecting Abnormal Trading Patterns of Corporate Insiders

Traders Magazine Online News, September 5, 2017

Carol Ozemhoya

Illegal insider trading tends to be something we don’t hear about until it’s hit the big news networks and newspapers as the SEC goes for the throat of the accused. By then, unfortunately, those committing it have made their gains, usually in the multi-millions of dollars, and the damage has been done to the stock, its company and investors.

And quite frankly, the jail time assessed doesn’t correct the damage done, and the fines rarely aid the investors in getting their money back. Many of those hurt are Average Joe’s and Jill’s who were just trying to pad their retirement nest eggs.

The act involves someone using information, which was not available to the public, buying and selling a company’s stock. Because the dealings involved are pretty much done on the sly, it’s been difficult for the governing body of the SEC to prove illegal insider trading, unless one of the cohorts tattles on the others or their actions become glaringly obvious. In some cases, a sharp mind around the action may take notice and become what’s called a whistleblower.

Writes Andrew Beattie of Investopedia:  “… insider trading is often difficult for the SEC to spot. Detecting it involves a lot of conjecture and consideration of probabilities.”

However, detecting illegal insider trading may actually be less complicated than it sounds, at least to the eyes of a keen observer who is familiar with the culture of financial entities and is hip to some of the tools available via artificial intelligence. It’s a matter of using temporal matching of the trade to its information source.

Key Components

Some terminology must be clarified:

          • Analyst estimates – these come from what an analyst estimates that a company’s quarterly or annual earnings will be. They are important because they help approximate the fair value of an entity, which basically establishes it price on the stock exchange.

          • Share volume – this reflects the quantity of shares that can be traded over a certain period of time. There are buyers and there are sellers, and the transactions that take place between them contribute to total volume.

How To Detect an Unusual Insider Trade

It must be pointed out that there are insider trades that are considered legal. Those go down when the trading party – the CEO of a firm – reports to the SEC that he/she bought shares in the company. This can also be true if a board member, or an executive buys shares through a stock option, as long as the SEC is made aware.

However, signs of illegal insider trading occur when trades occur that break out of the historical pattern of share volume traded. Another hint to perhaps illegal insider trading is when a lot of trading goes on right before earnings announcements. That tends to be a sign that someone already knows what the announcement is going to indicate, and it’s an obvious violation.

Bells should also go off when trades are linked closer to the actual earnings instead of what the predicted earnings were. In this case, it’s clear the trades – especially made by someone close to the company – stemmed from information that was not readily available to the general public. 

For more information on related topics, visit the following channels:

• Equities