With the earnings announcement of AA (Alcoa) this past Monday, the first quarter of earnings season 2015 has officially started for the US equity markets. So here are some thoughts past and present of how I trade leading up to, during and after earnings announcements.
Before I start I would like to state that I NEVER take a stock into earnings and can’t remember the last time I did, but let me also say that I USED to take a position in a stock coming out with earnings from time to time and to be quite honest I usually took the “shot”, and it was a shot, when I was either having a very good month or was just treading water and wanted to force something or create a catalyst in my P&L.
Either way, this is not the way you want to make money and we all know it. Do I really want to be bailed out when I’m treading water by gambling if AAPL will beat/miss etc? Might work and if it does will pay pretty well but too often investor’s trade options or the underlying stock itself in hopes that they will make money in reaction to an earnings report, but bottom line it’s the wrong way to trade intelligently.
The Right Way
The right way to focus on an earnings play is to take into account the stocks volatility, its current trend as well as the current market conditions. I also take into account how the correlating stock’s group has been acting and whether the stock in question is a leader, the “best of breed” or a laggard. And most of all has there been volume and range leading up to the earnings release?
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More times than not the current stock price of a company about to report can provide clues with respect to future action. Has the stock been advancing/declining into the numbers? Has the company pre-announced or issued any guidance leading up to their report or has there been any material news since the last earnings report or even so, is there still play or hangover from the last earnings report? An extra amount of homework has to be done with this style of play. Look at how a company has done against earnings estimates historically and not surprisingly the biggest moves in the market come from stocks that beat or miss numbers by a wide margin.
Trading earnings reports are especially difficult because there is little reaction time and it’s tough to formulate a much necessary trading plan which is why better traders make money trading earnings releases. We are able to read between the lines and I find the less experienced traders that do make money are usually lucky (no offense) and often get in bad habits because they become too cavalier when trading earnings releases.
In closing, I really believe that there are different disciplines to apply when trading an earnings release and in particular an active earnings day. I find more times than not, and I am guilty from time to time, that traders focus more on their losers more than winners, often selling their winners (which usually keep on going) and holding their losers (which by traders law, usually get worse).
Also, there is so much action that many traders trade a basket of stocks to see what sticks and what doesn’t which takes away from why things are working and therefore not really being able to sink their teeth into a solid money making position. I always say that there is always another trade and I say this especially during earnings season. You aren’t going to be able to catch everything and when traders see a position that works that they wished to enter, they pound the table in disgust because they missed “the one” and lose focus. The right way is to split the day in two and do your homework during the lunchtime session. See which stocks have volume, range and are showing relative strength.
Note which stocks close near the high and how the corresponding group acted. This is pertinent for many reasons. First, stocks, especially earnings plays, stay “hot” or in rotation for a couple of days and thus have good volatility and more price forgiveness. Secondly, earnings plays that close strong with range and volume usually have some form of follow thru into the next session. And lastly, like stated above, stocks performance leading up to, during and after numbers is a great indication for future price movements. We are not analysts so trade the reaction and let the stocks tell you what to do.