It can be intriguing to follow the directors dealings in various companies. Sometimes they can give you a good indication of future prospects and of how the share price is likely to perform in the future, and other times director dealings are best ignored. If you learn to interpret them correctly, and trade CFDs on their companies shares, you’ll find that directors’ deals can be a useful gauge of market sentiment and can thus form part of a successful trading strategy.
First, let’s clarify one point. We are not talking about insider trading, which is a criminal offense. Insider trading involves making financial investment decisions using confidential information, and this is unfair on investors in general and is covered by insider dealing regulations. Directors are not allowed to trade on the basis of insider information, and by this I mean unpublished price-sensitive information until this is disclosed to the public as otherwise they would be deemed to have an unfair advantage over other market participants.
Trading is also not possible during the ‘closed period’, which spans the weeks preceding the publication of company results updates. This period runs from the last day of the accounts up to the date the accounts are in effect published unless longer than two months, in which case it is restricted to the two months prior to the release of the figures. However, directors of a company can trade in their own shares, and are probably in the best position to assess the future prospects for profit and growth. When you trade the shares with contracts for difference, you multiply the effectiveness of your trading capital by using the leverage that CFDs enjoy.
Following directors’ dealings can be a rewarding occupation although care needs to be taken as directors dealings can be less transparent than they may at first seem. The London Stock Exchange requires that directors must announce any holdings in their company’s stock within 5 business days and the company then has to alert the London Stock Exchange by the end of the following day at which point the news is made public. More significance is often given to purchases rather than sales as this demonstrates a higher degree of commitment. Directors are not allowed to buy or sell shares in their own company in the two months preceding results, so a cluster of buying just before or after this period can be a very bullish signal. The point being, that the results refer to an accounting period that has probably closed some several weeks before, whereas the directors will have a good idea how trading is progressing since that time. A particularly bullish sign is when good results are published, the stock goes up, and the directors still buy stock, even after the rise! CML Microsystems (CML) was a particularly good example where a cluster of directors bought shares after the results came out in June 2000. The stock continued to rally strongly over the next few months as can be seen in the chart below.
If you Google ‘directors dealings’, you will find there are several websites that report when directors of companies trade in their own shares. This is public information, as directors are required by law to disclose their trades in their own company, both buying and selling. You should be careful before taking directors trades as an indication to buy or sell CFDs in the company, as there can be several reasons that directors trade their own shares.
A similar situation that could be worth watching is First Active (FTA). Strong results were out at the end of February 2002, followed by a share price rise and a cluster of director buying.
Note: those examples of director dealings are taken from the past on purpose (not because the articles are out-of-date). The examples are only provided as an illustration and are not intended to be a tip to buy into these companies.
Thus, if directors are buying shares in the company, this can be a good indication for the future, particularly if more than one director is doing so – in particular if the purchases involve the chairman or CEO making a major investment. The size of the investment is also important. News that a new chairman or chief executive officer (CEO) has taken a sizable stake in a company that he has just joined is often a bullish signal and is likely to attract other investors to follow suit. But you should consider that this may also be a ploy to boost public confidence in the company, particularly if there has been some damaging news and directors want to improve market confidence. Bear in mind that the director probably has a significant investment in the company already, and the value of these existing shares is at risk if the public loses confidence, so a further modest investment could prove to be prudent if it saves the shares from a price collapse.
While buying shares can be interpreted positively much of the time, directors selling shares in their company is hard to categorize as the reason for sale could be unrelated to a company’s prospects (directors are also known for selling shares for personal reasons). Deciding whether to short with CFDs should be based not only on the directors actions, but also on other indications that the shares will decline. Without knowing the directors personal circumstances, you do not know whether they need to sell shares to meet personal commitments, such as school fees, or to fund a new car. They may have reached a stage in the company’s expansion when they feel that they deserve to spend some of the profits made on a new house. They may even just be seeking diversification in case something happens, without any reason to expect a problem. Once again, if more than one director takes this action, it may be more important especially if the sales are significant and it could signal a good opportunity to go short.
So in summary, watching the directors dealings can be a worthwhile CFD strategy, and it is easily done with the facilities of the Internet. However, it’s best not to base your trading solely on direction dealings, but to also take account of other information and the bigger picture.