3 Tricks to Playing Earnings
It’s earnings season, that magical time each quarter when companies report their numbers to Wall Street. There’s good reason why investors pay so much attention to corporate earnings — after all, positive numbers rally double-digits within a single trading session.
Heck, a well-placed trade ahead of earnings season can make a trader’s year…
But it’s not all excitement and anticipation during earnings season. There’s a flip side to that coin. That’s because while good earnings can pop shares higher, bad profit numbers can smash shares dramatically lower.
Quite frankly, it’s a lot like navigating a minefield!
All of that said, earnings don’t have to be a high-stress trading scenario for you. In fact, if you apply the right strategy, this time of the year can be very lucrative. Today, I want to show you three simple tricks that will help you take home bigger gains this earnings season.
First off, a bit of background. It’s important to mention that you don’t need to be a high frequency day trader to take advantage of the strategy I’m about to share with you. Even if you’re a long-term, buy-and-hold investor who spends more time looking at balance sheets and income statements than stock charts, this approach can help reduce your risks and put more cash in your portfolio.
With that, let’s dig right in…
Trick 1: Don’t Anticipate Earnings
The best way to avoid stepping on an earnings landmine is by not anticipating a stock’s earnings in the first place. That may sound like a bit of a letdown, but let me explain why this first trick is so crucial…
You see, a lot of newer investors get confused about the difference between trading and speculation. Put simply, trading is about exploiting advantages you can wring out of the market, whereas speculation is gambling. There’s a huge difference between the two — the biggest is the fact that under a well formed trading strategy you shouldn’t be capable of blowing up your account. As a speculator, you’re counting on random chance to make money.
99% of the time people bet on companies ahead of earnings, they’re speculating pure and simple. That’s why it’s a terrible idea to anticipate earnings.
I know that from experience…
A (long) while back, I was trading options on some large-cap stocks — names like Ford, Apple, and Citigroup — while I’d close most of my positions same day, one day I decided to hold onto Citigroup calls heading into the weekend as I waited for the setup to develop a bit further.
Unfortunately, while I was well aware of the market’s closure for a market holiday that Monday, I hadn’t factored it in when I originally set up my trading plan. Although I’d intended on selling the options ahead of Citi’s earnings (which would have given me a relatively nice gain), I got stuck holding the position and ended up closing out most of my contracts for a loss.
That’s a mistake I only made once. Don’t let it happen to you…
Trick 2: Look at Reactions
There’s more to a sound earnings season strategy than just sitting on the sidelines. In fact, you could actually make significant profits during earnings season.
Most people think that the biggest trading gains come by buying a stock ahead of earnings, then holding onto shares as they move higher. But that’s just not true — those are speculative gains, not trading gains. That logic is a lot like saying that the best way to strike it rich in Vegas is to hit a slot machine jackpot; it’s a true statement, but good luck actually pulling it off without going broke first.
Remember, we’re not speculators — so we’ve got to find an exploitable advantage. That’s where reactions come into the picture…
After waiting for a firm to announce its earnings numbers, you want to pay attention to how Wall Street reacts to the numbers. More specifically, how’d the earnings perform against Wall Street expectations, and how’s Mr. Market behaving as a result? (You can find analyst estimates for most stocks by going to major financial sites like Yahoo Finance.)
A stock that beats expectations and then rallies isn’t anything special. But a firm that misses earnings and either holds its ground or moves higher is a different story. That sort of unexpectedly positive reaction means that there’s some exploitable strength in shares. That could provide a good opportunity to be a buyer…
Trick 3: Rethink Your Analysis
Finally, after waiting for earnings to happen, then gauging reactions, it pays to put the puzzle together by rethinking your analysis. By that, I mean look back to the factors that made you interested in shares and decide how the market’s reaction to earnings changes your outlook.
Let’s say that you’re thinking about buying a stock because it just had a technical breakout. But you followed our first earnings trick and waited for the numbers to come out before buying shares.
Then, using trick 2, you noticed that even though earnings were missed, shares moved up a few points in the next session. That’s a very good sign.
Trick 3 involves looking back at the technical reasons you wanted to buy shares in the first place and making sure that the bullish earnings clues still jive with the stock’s setup.
If they do, you’ve got an especially strong buy signal on your hands…
Now, if you’re a fundamental investor, trick 3 may be as simple as seeing whether you’d still want to buy the company’s stock after it posted those lukewarm numbers. If your core reason for buying shares isn’t valid anymore, it makes sense to stay away. Earnings can turbocharge gains on a good name, but they can’t turn garbage into gold. That’s why it’s essential to rethink your analysis before buying.
When earnings season rolls around each quarter, that’s the exact process I go through on every stock I look at. By using these three simple tricks to trade earnings season, you can avoid the scariest risks in the market and pad your portfolio in the weeks ahead.