Led by some of the smartest people on earth, the hedge fund industry wields market-moving power. The industry’s assets grew by nearly $229 billion last year, to just over $2 trillion.

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Without being an insider, how can individual investors know what hedge funds are buying or selling? The Security and Exchange Commission requires hedge fund managers who manage over $100 million to file a Form 13F every quarter. These documents quietly reveal what hedge funds and other large institutional investors are buying and selling.

One of my favorite investment tactics is to look for patterns in 13F filings. Companies that have attracted interest from multiple hedge funds can signal a great buying or selling opportunity.

I call these buying and selling patterns hedge fund swarms. My basic definition of a hedge fund swarm is when three or more hedge funds buy or sell a particular stock during a single quarter. Obviously, the more funds in the swarm buying or selling, the more powerful the signal.

I recently discovered a company that has attracted a swarm of hedge fund activity in the most recent quarter. Outerwall (Nasdaq: OUTR) (which was brought to my attention by my colleague Marshall Hargrave) is best known for operating the ubiquitous Redbox movie rental kiosks and Coinstar stand-alone coin-counting machines.

The company operates 43,700 Redbox kiosks and 20,300 Coinstar machines. It boasts a $1.8 billion market cap and had revenue of $2.3 billion and gross profit of $731 million last year.

	Outerwall
	Despite the buybacks and improvement in the bottom line, the hedge fund swarm may now be signaling that the top is in for OUTR.

The company is flush with cash, which has attracted several hedge funds, including activist fund Jana Partners, TPG Axon Partners and Park West Asset Management. These funds started acquiring shares in the company after the price was knocked lower by weak quarterly results. This swarming, combined with the company’s aggressive share buyback program, helped push OUTR from under $50 to a recent high over $72.

Specifically, with the encouragement of Jana Partners, which had owned 13.5% of the company, Outerwall said it will return 75% to 100% of its free cash flow to shareholders. In addition, the company plans on continuing these repurchases throughout 2014. In keeping with this strategy, the company recently purchased $350 million of its shares for $70.07 or less in a modified Dutch auction.

Jana is said to be exploring other strategic options for the company, including a possible sale. Investors who jumped onto the stock when the hedge fund swarm was first revealed have made out like bandits — but despite the buybacks and improvement in the bottom line, the hedge fund swarm may now be signaling that the top is in for OUTR.

Jana Partners has trimmed its stake in the company to 8.4%. The fund says this reduction is due to “regular portfolio management activities” and that it remains highly supportive of Outerwall.

However, other hedge funds are also dumping shares, which constitutes negative swarming activity. For example, Marathon Partners have reduced its holdings by 60%, Park West Asset Management lowered its exposure by 17% and Fine Capital Partners sold 9% of its shares.

I think this hedge fund selling goes beyond “regular portfolio management activities” and is signaling that investors should proceed with caution with the stock.

Risks to Consider: There are high risks on both the bullish and bearish side in Outerwall. The company remains innovative and is aggressively trying different kiosk concepts to discover the next big hit. Most promising is its EcoATM designed for the recycling of personal electronics. However, the massive return of cash to investors may interfere with funding new innovations. In addition, the selling by hedge funds may be signaling there is more than meets the eye in Outerwall. Always use stop-loss orders and diversify when investing.

Action to Take –> I am short biased on this company and think any good news is already baked into the share price. However, although the hedge fund swarm selling is sending a strong negative signal, I remain uncertain about the direction of Outerwall’s stock price. Therefore I use my channel trading method to determine the proper trade direction from the present level. Draw a horizontal line on the daily chart at $72.50 and another horizontal line at $63. Should price close above the upper line at $72.50, enter a long position with the initial stop level at $71.50. Should price continue to drop and close below the line at $63, enter a short position with initial stops at $64.

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