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Specifically, illegal insider trading means buying or selling a company's stock based on material information not in the public domain. (Legal insider trading is when corporate insiders buy and sell stock in their own companies, which is a common occurrence.) So if your neighbor, a corporate executive, reveals after a few drinks that his company will sign a secret mega-contract next week that will likely send the stock price soaring, buying that stock would be insider trading. By contrast, if that information appeared on the company's website, in an analyst's report, or in a newspaper article, it's public information and anyone can safely act on it.
While you may not have a neighbor with breaking corporate news, you can infer some insider knowledge-company profits, impending mergers or acquisitions, future dividend hikes or cuts, whether earnings will be better or worse than Wall Street expects-from some less-visible public information, and still stay out of trouble.
Companies themselves prohibit insider trading for a period prior to an earnings announcement. The SEC presumes that sales or purchases that take place within that time are linked to the effect the earnings announcement will have on stock prices.
But there's a limit to what the SEC can do. Suppose an insider knows the company's earnings are going to suddenly turn down. He sells, and the earnings are reported. The SEC inquires, and the executive in question says he sold because he wanted to pay off his home mortgage, contribute to his parents' nursing home care, or fund his kid's college education. The SEC can't read his mind and ferret out his other motivations.
Nor can you. However, since insider trades are publicly reported, you can track them for unusual patterns. The same intensity of activity every month doesn't mean anything. One or two people might have a legitimate desire to sell, but when several insiders are doing it, that tilts in favor of the likelihood that they know something.
Various publications and subscription services report insider buying and selling. Check out The New York Times online at http://www.nytimes.com/pages/business/index.html; click on Company Research, plug in the company's name or ticker symbol, then follow the link to Insider Trading. Or try finance.yahoo.com or http://www.morningstar.com, two more good free resources. Subscription services, such as http://www.insiderscoop.com, offer real-time updates as new forms are filed with the SEC, and send e-mail alerts for stocks you're watching.
Here's how I once successfully used public information about insider buying: Last year, I noticed there was a lot of insider buying of MBNA, a banking and credit company. I felt very strongly that this was a meaningful signal. I purchased the stock at about $20 a share in June 2005, and within a matter of a few weeks, I sold the stock at 26. Early in 2006, MBNA merged with Bank of America.