Information Trading Strategy (What Pros Do)

A recent academic paper titled “An Information Factor: What Are Skilled Investors Buying and Selling?” introduces a fascinating, evidence-backed trading strategy that builds on a deceptively simple premise:

Follow the money — but not just any money. Follow the informed money.

By combining signals from insiders, short sellers, and options traders, the authors developed what they call an Information Factor, a tool to identify what smart, skilled market participants are buying and selling. Here’s how the strategy works, and why it might be worth your attention.

Three Core Information Signals

The researchers used three publicly available metrics to capture what informed investors are doing:

1. Insider Trading Activity

This measures the net buying or selling of company shares by corporate insiders, such as executives or directors.

Insider buying is typically interpreted as a bullish signal — these individuals often have deep insight into the company’s future prospects.

2. Short Interest

Short interest is calculated as the ratio of shares sold short to total shares outstanding.

A high short interest is considered a bearish signal, as it indicates that many market participants expect the stock to decline.

3. Option Volume Relative to Stock Volume

This metric compares how actively a stock’s options are being traded relative to its underlying stock.

High options volume, particularly when speculative, may reflect uncertainty or negative sentiment. This is a bearish signal.

Ranking Stocks Using the Information Score

At the end of each month, the authors ranked each stock from 1 to 100 for each of the three signals:

• Insider buying = high rank (positive)
• Short interest = low rank (negative)
• Option volume = low rank (negative)

They then calculated an Information Score for each stock by taking the average of its percentile rankings across all three factors.

This produced a single composite measure for how “informed” the trading activity around a stock appeared to be.

Forming the Trading Strategy

Once all stocks were scored, they were sorted into 10 decile portfolios, from the lowest to highest information score. These portfolios were:

• Equal-weighted
• Rebalanced monthly
• Held for one calendar month

To evaluate performance, the authors constructed a long-short portfolio that buys the top decile of stocks (the 10% with the highest information score) and shorts the bottom decile (the 10% with the lowest score).

Performance Results

The results showed that the Information Trading Strategy produced a strong return spread between the top and bottom deciles.

• The strategy was statistically significant across different time periods.
• It showed robust returns even after accounting for trading costs and slippage.
• The strategy worked out-of-sample, confirming its reliability across different data regimes.

This suggests that the behavior of insiders, short sellers, and options traders contains useful, predictive information — and that combining their signals leads to a more powerful composite factor.

Why It Works

The beauty of the strategy lies in its simplicity and its diversity of inputs. It combines the insights of:

• Corporate insiders with fundamental, long-term views
• Short sellers who often conduct deep research on overvalued or struggling companies
• Options traders reacting to near-term sentiment or volatility

By capturing information from these three groups, the Information Score paints a more complete picture of informed investor behavior than any single signal on its own.

How You Can Apply This

This strategy is surprisingly implementable for retail and systematic traders:

• Insider data is available from the SEC’s EDGAR database or sites like OpenInsider.
• Short interest is published biweekly by FINRA and exchanges.
• Options volume is available from most brokers or data platforms.

You can replicate the approach by:

1. Ranking stocks monthly on the three signals
2. Calculating the average score across all three
3. Buying the top 10% and shorting the bottom 10%
4. Rebalancing monthly or quarterly

Even a simplified or long-only version could still capture much of the strategy’s edge.

Final Thoughts

The Information Trading Strategy is a great example of how behavioral and structural insights can be turned into systematic edges. Instead of chasing hype or price momentum, it quietly follows the decisions of experienced market participants.