Few things are more anxiety-producing than hearing that company insiders of your favorite stock are about to sell off large numbers of shares. The stock may be cruising along, delivering images of that trip to Hawaii or 40-foot boat you’ve always wanted. Then suddenly, you hear an announcement like this:

“Google co-founders Larry Page and Sergey Brin plan to steadily sell off up to 10 million shares of stock over the next five years, according to an SEC filing.”

That announcement came out in January, 2010. However, over the past three years, GOOG has risen from about $550 to its current price of $717. A 30% gain in three years is decent, if not Earth-shattering. Other notable tech stocks, such as Apple (NASDAQ:AAPL) up 128% and even IBM (NYSE:IBM) up 50%, have outperformed Google during the same time frame.

While those sales may have stalled Google’s appreciation somewhat, had you sold your Google stock in January 2010 expecting it to crash, you would have missed that 30% rise.

It’s often said insider selling can be a tip-off that insiders know their stock is about to underperform the market. While that’s sometimes true, it’s also true that quite often insiders sell for personal financial reasons that have absolutely nothing to do with bad times ahead for their company.

So, when insiders at a large publicly traded company begin to sell off a large amount of stock, how do shareholders know if they should rush for the exits? Let’s take a look at the nuances that dictate whether inside sales are cause for alarm.

Don’t Panic

These days it’s also common for companies to pay smaller salaries to company insiders and compensate them instead with stock shares and options. Keep this in mind, because often an insider could be selling shares simply to raise some personal capital.

It’s also an axiom of the stock market that while insider selling is often insignificant because it can be done for any number of reasons, insider buying almost always indicates that the corporate officers have reason to believe better times are ahead. Therefore, insider buying is usually much more important than insider selling.

But how do we decipher the insignificant from the more significant insider selling? Here are several clues that the selling can probably be ignored:

• Automatic sales are insignificant because they’re scheduled at intervals established far in advance and are simply done to generate income for the insider over time.
• Option sales are insignificant because they’re governed by expiration dates.
• If only one corporate insider is selling, it’s less likely to be significant because it may just mean that one person has a particular need for revenue at that time.
• When a stock has run up quite a bit, an insider may feel it’s prudent to take some profits. In such cases, it’s even common to see the stock trade higher for awhile. Nobody, not even the CEO of a company, can predict the exact top or bottom of a stock advance with absolute certainty.
• The selling is done slowly, over a long time frame, such as with Google.
• The insider has no clear history of selling near price peaks

So, looking at the Google insider trades, the sales were scheduled far in advance, have to-date been performed over a dozen successive quarters and at a wide range of prices. In essence, during this three-year period, this selling has been the norm — rather than the exception — and is, therefore, not really notable.

Red Flags

Conversely, several telltale signs indicate when insider selling may be significant and a warning that a large drop in price is expected over the next few months:

• Significant selling is likely to be done without major announcements or fanfare.
• A large number of corporate insiders are all selling within a short period of time.
• The sales are made on the open market.
• The number of shares sold and subsequent dollar amounts realized are quite large.
• The insider(s) has a previous history of selling near the peak of the stock’s price.
• Selling occurs after a large decline in the share price of the stock. This may indicate that insiders have little faith that their stock is going to rebound.

Another thing to note is that when the level of overall insider selling across all stocks rises, it often indicates that the stock market in general may be about to reverse course and head lower.

Such was the case in late April 2012, when insider selling among S&P 500 companies rose to the highest level in more than 10 years (see chart). Almost 1,800 insiders sold company shares over a three-month period. Over the next two months, the S&P fell 8.5% from 1,400 to 1,280.

An example of significant insider selling occurred at Dollar General (NYSE:DG) in October 2012. Over seven trading days, 10 different corporate insiders sold over 90 million shares of DG, amounting to some $4.7 billion.

Several factors made this selling significant. A large number of insiders were involved, the share and dollar numbers were enormous, most of the sales were in the open market and not automatic, and the trades were made over a short period of time.

How did DG perform after the insider selling subsided? Within a few weeks, it fell from $51 to $45. Two months later, the stock was trading as low as $41. The insiders had sold when it was almost 20% higher.

So, keep the Google and Dollar General examples in mind, and don’t automatically assume the worst when you hear about corporate insiders selling stock. Using the criteria outlined here, investors can make sound decisions about to whether insider selling means it’s time to head for the exits.

As of this writing, Ethan Roberts didn’t own any securities mentioned here.