When directors put their own money on the line, should you follow suit?

For private investors looking to sharpen their edge, tracking insider activity – the share dealings of company executives and board members – can be a powerful tool.

After all, who better to judge a company’s true prospects than those running it from the inside?

But while insider trades are disclosed to the market, not all carry the same weight. The real challenge lies in distinguishing meaningful signals from mere background noise.

The logic behind tracking insider dealings lies in the unique information advantage that directors and senior executives hold.

They sit at the heart of strategic decision-making and have a far clearer view of a company’s current health and prospects than external investors.

While regulations enforce the fair disclosure of price-sensitive information, insiders inevitably operate with a deeper understanding of the business — its challenges, opportunities and future catalysts.

A growing body of academic research shows that these so-called ‘smart money’ signals — including insider buying — can often predict future share price performance.

Here, Stockopedia looks at analysis of over 105,000 UK director trades from 2014 to 2024 to identify the ‘sweet spots’ in insider buying activity that most reliably point to future outperformance.

City rules enforce the fair disclosure of price-sensitive information, but insiders inevitably operate with a deeper understanding of the business

Rule 1: Buy signals outweigh sell signals

A fundamental principle in interpreting insider activity is understanding the disparity between buying and selling.

Many investors may feel uneasy when a director sells shares, but research shows buy signals are far more informative.

Insiders sell for a variety of reasons unrelated to a company’s outlook, such as diversifying wealth or fulfilling tax obligations.

Sales often stem from personal financial needs or exercising stock options, which don’t necessarily reflect on the company’s prospects.

Consequently, the correlation between director sales and poor future returns is weak, except in cases of extremely high stock valuations or deteriorating fundamentals.

On the other hand, insider purchases typically signal belief in the company’s undervaluation and potential for growth.

As veteran investor Peter Lynch observed: ‘Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.’

Directors often also act contrarian — buying when the market undervalues their stock and selling when it’s overvalued.

For example, stocks typically see a 2.5 per cent gain in the first month following a director purchase, with larger trades pushing that to 5 per cent, and even more significant gains over the next 100 days when the trade is made by a CEO or CFO.

Insider purchases typically signal belief in the company’s undervaluation and potential for growth.

Rule 2: Cluster buying — Multiple directors make a stronger case

‘Cluster buying’ is where several directors purchase stock within a short time period. When more than three directors buy shares in the preceding three months, the average monthly returns are typically 2 per cent higher than the market’s.

This ‘conviction trade’ signals a stronger consensus among the leadership about the company’s prospects, making it a powerful indicator of future share price outperformance.

Cluster buying also reduces the risk of misinterpreting isolated purchases that might stem from personal reasons rather than a genuine belief in the company’s future.

A great example of this dynamic comes from Rolls-Royce in 2022. As the company faced pandemic-related challenges as well as a multi-year turnaround strategy, multiple directors began buying shares.

At the time, the stock was priced at about 100p. By the start of 2025, after a transformative shift under a new CEO, the stock surged to over 630p. Directors who bought in 2022 — and investors who followed their lead — saw a more than fivefold return in just two and a half years, far outperforming the FTSE All-Share’s roughly 15 per cent return during the same period.

Rolls Royce directors who bought shares in 2022 were rewarded with strong gains 

Rule 3: Follow the top executives

Within a company’s leadership, the flow of critical information is not equal. Board meetings, where sensitive operational and financial details are discussed, are the primary information hubs.

Executive director buying — particularly by the CEO and CFO — carries more weight than purchases made by other officer, and are considered clearer signals of future gains.

On average, stocks see a 3 per cent increase over 50 days and a 3.5 per cent gain over 100 days following a CEO or CFO purchase.

This highlights the market’s strong belief in top executives’ buying decisions as a vote of confidence in the company’s trajectory.

Insiders buys are a better indicator than insider sells 

Rule 4: Larger trades in undervalued, small-cap stocks

The context of insider buying is key to understanding its predictive power.

Director purchases hold more significance when the company’s stock appears undervalued, particularly in small- and micro-cap companies.

In less-followed market segments, large institutions like hedge funds may struggle to trade in size, allowing insider purchases to have a more noticeable impact.

Research by Lakonishok and Lee, which analysed insider trades from 1975 to 2005, found that director buying was especially predictive in small-cap value stocks.

It showed that substantial purchases by multiple insiders resulted in the highest returns, aligning with Stockopedia’s research, which shows that stocks typically rise by around 5 per cent within the first month following a significant director purchase.

Combining insider buys in undervalued small-cap stocks with strong fundamentals, such as value, quality, and momentum, can further enhance the probability of success. In some cases, this approach has resulted in success rates exceeding 95 per cent. 

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Beyond the buy: Context matters

While focusing on these insider buying ‘sweet spots’ improves the odds of identifying promising investments, insider buys should not be viewed in isolation.

To make the most of these signals, they should be integrated into a broader investment framework. Insider buying signals are most potent when used alongside other analyses, such as fundamental strength, market sentiment, and macroeconomic conditions.

Stockopedia’s StockRanks system, which evaluates stocks based on value, quality, and momentum, can help investors combine insider buying signals with these critical factors. By identifying stocks that score highly across these areas and also exhibit positive insider trading activity, investors can pinpoint stocks with significant upside potential.

Stockopedia’s StockRanks system evaluates stocks based on value, quality, and momentum

Unlocking the power of informed decisions

Understanding the motivations and actions of those with the most intimate knowledge of a company can provide a valuable edge.

By focusing on buy signals over sell signals, identifying cluster buying, prioritising purchases by top executives, and seeking large trades in undervalued small stocks, investors can better identify the ‘sweet spots’ of insider buying that truly matter.

However, even the most compelling insider buys should be part of a more comprehensive investment approach.

Combining insider signals with a deep understanding of company fundamentals and market dynamics, alongside tools to track and contextualise insider activity, can significantly enhance the likelihood of long-term success.

This article is part of Stockopedia’s The Smart Money Playbook series. As a special offer This is Money readers can get 25 per cent off a Stockopedia membership.

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