Benefits Of insider Trading To Financial Markets

In Jaikishins NUS honors year thesis, he examined 653 insider transactions between January 1989 and December 1990. He found that insiders outperformed the market and enjoyed a posttrading abnormal return from day 0 to day 250 after their transactions.

Most of the abnormal returns was gain from sell trades (a return of 116.87 per cent); that is the share price declined substantially after they sold their shares. On average, however, they lost money when they bought their shares. They chalked up losses of 44.04 per cent. Outsiders who followed suit after the trades were reported also made similar gains or losses. His study, however, did not take into consideration trading costs.

Jaikishin found that transactions of small company insiders did not contain more information than those of bigger firms. The explanation given for the loss-making buy trades of insiders was that insiders tend to conceal information-laden buy trades through the use of family members or friends while using their own names only for trades without information.

Many a time, insiders also go into the market to buy their own shares in order to support the share price. Or, some of the trades

were carried out to confuse the market or mask their real intents.

I randomly selected 17 trades by insiders in the last one year. The companies involved were Cerebos, Lum Chang, Ho Bee, Beyonics, Multi-Chem, Eastern Publishing, Pan United Corp, Del Monte, SingTel, DBS, Frontline Technologies and Datacraft. Out of that, 13 were 'buy trades and four seIl trades. Assuming you had followed the insiders, your average abnormal return after one week would have been -2 per cent after taking into account two-way transaction costs of 2 per cent. I calculated abnormal return as the excess return over the Straits Times Index return. No risk adjustment was made.

The two-week average abnormal return was -1 per cent, and the average abnormal return for one month and three months subsequent to the trades were 4 per cent and 5 per cent respectively. Particularly, you could have reaped huge profits if you had followed Datacrafts chief operating officer Koh See Heong when he cut his personal interest to 10,868 shares after he sold 220,000 shares at US$3.35 each on Oct 4, 2001. In the following one month, Datacrafts share price fell to US$1.79. Excluding Datacraft, the average abnormal returns for the 1-week, 2-week, 1-month and 3-month periods were -1 per cent, 0 per cent and 1 per cent and 3 per cent respectively.

Based on the limited sample size, the observations which can be made are: Sell trades appear to contain more information. But this could be due to the overwhelming effect of Datacraft. Trades by insiders appear to bear substantial fruit only some three months down the road.