It appears logical to assume that directors know better than outsiders about the company and its prospects. However, in practice, trying to profit from following directors' dealings is unlikely to be successful. In 1993 a unit trust called The Ely Place BRI Directors Dealings was set up to exploit opportunities flagged by directors dealings. Its performance was very poor and was wound up five years later when it was ranked 154 out of 160.
Significant directors' buying is prima facie a positive. But private shareholders buying following this will not necesarily profit. In the case of small companies, the share price often rises before the private shareholder is able to deal at the prices that the directors paid. Morevoer the directors sometimes over-estimate the value of their company. This happens in small companies as well as big. For example, the directors of Barclays bought over £4 million of shares at prices ranging from 551p to 689p between 2 Aug and 2 Nov 07. This did not stop the price falling and about two years later the price touched a low of 59p.
Directors' selling, specially in small companies, should be taken as a red flag. There have been numerous instances of the share price collapsing shortly after heavy directors' selling. While there may be personal reasons for the directors selling, it would probably be prudent to follow the directors' lead and sell, specially if there is anything "mysterious" about the company. For example, there was a company called Northern Leisure that seemed to have a very good business model, low PEGs and good news flow. Its share price rose quickly. This was stoked by an announcement that the company had a bid for it but the company would not disclose details of the bid. This caused the price to rise further while the bid was being considered. After some time, the company announced that the bid was abandoned and the chief executive sold a lot of shares. The share priced collapsed, never to recover.
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