Dear Reader!
Can you guess what United Health (UNH), JP Morgan (JPM) and Citigroup (C) all have in common? These companies are part of the heavy hitters kicking off earnings this coming Friday!
It’s October and that means market volatility will get a shot in the arm as 270 companies report their quarterly earnings.
You’ve heard the phrase, “The devil is in the details,” so, if you have stock investments, you may be very interested in listening to conference calls and hedging concerning investments.
But if you simply want to capitalize on the upcoming volatility associated with earnings season, then you’ll want to be sure to trade earnings the right way!
There is a right way and wrong way to trade during earnings season, and if you’ve ever traded a call option through earnings, watched the stock’s price rise on the earnings announcement, and then looked at your call option only to find it has lost money, then you know exactly what I’m talking about.
It happens in every earnings cycle – traders lose money on both calls and puts trades despite price moving in the desired direction.
To trade earnings the right way there are two things that can give you an edge.
The first is making sure you’re trading on the right side of earnings – before the stock reports, not as it reports.
The second is to stay away from the 50/50 probability you have when you decide whether the stock’s price will go up or down upon its earnings report. Instead, we can gain an edge by observing patterns that stocks might have before they report.
Instead of guessing how a stock’s price might behave before it reports earnings, I let my proprietary software, I call Brutus, identify the repetitive patterns for me.
So, it’s time to stop bad practices and put yourself on the right side of earnings trading.
The first thing I want you to do is to change your mindset about when to trade earnings. It’s very enticing to trade earnings because you’ve seen mega gaps in the stock’s price after they announce.
Mega gaps in the stock’s price, however, are not the norm, and selecting the right direction a stock’s price might move can be even trickier. It’s a coin’s toss, and unfortunately, it’s more common to lose money larger amounts of money on losers than what you might gain on winning trades.
It can easily turn into a losing strategy.
It’s time to change your mind set about when to enter earnings trades
I know there is a big appeal to speculate on the direction a stock’s price might move after reporting earnings, and if you look at the Paypal’s (PYPL) chart below, you’ll see what I mean.
The day after PYPL reported earnings in Q1 of this year, it dropped a staggering 23%. This kind of move is enough to get any trader’s heart pumping.
Now for the hard reality of this movement: If we knew for certain the direction and magnitude each stock would move upon reporting, well…
You get the idea.
There are too many factors involved with earnings reporting.
It’s easy to look at the broader market and see the impact it is having on stocks, and you can spend hours reading through analyst reports to get a sense of consensus expectations.
But after all the hard work in deciphering market conditions and analyst’s estimates, the real trick is knowing how investors will respond to the actual report.
You may have had the experience of hearing what appears to be a “good earnings report,” only to see the stock’s price tank immediately after.
It’s enough to make anyone scratch their head. Oftentimes price movement after earnings makes no sense.
Part of the reason is due to the expectations of investors rather than the actual numbers being reported.
Knowing what investors expect can be a guessing game. If investors “expect” a GREAT report, but only receive a GOOD report, they’ll punish the stock by selling off.
You’ll definitely feel the frustration when you hear what seems to be “good” earnings news, only then to watch the price crash afterwards.
To avoid getting caught in this earnings snare, I want you to rethink how you trade earnings.
Trading earnings the right way – before the report is released
You were able to see the excessive movement PYPL made on its first quarter earnings report in the graph above. But, there’s something else to consider – how much a stock’s price can move before its earnings.
Let me use Paypal for another illustration in the chart below.
The magnitude of a stock’s price movement may not seem so obvious when you consider several trading days of price movement versus a single trading day as you saw in the image above, but let me point out the sizable price movement PYPL had before it reported earnings.
The image below shows two earnings reports for Paypal.
In both cases the stock had a stronger movement in price than it did on a single earnings day illustrated above.
If you’re like me you may question how we would know how much a stock’s price will move before its earnings announcement.
The truthful answer is nobody knows for certain, but that’s why I focus on patterns and not pundits.
I mentioned above that my proprietary software, Brutus, is designed specifically to monitor past price action of stocks before they report earnings, and to sniff out repeatable patterns.
Then, to give me an edge in earnings trading, Brutus answers four questions for me:
- What is the best entry date for the trade?
- How much will option premiums become inflated to enhance my trade?
- What kind of return am I capable of realizing by trading ahead of earnings, and…
- When should I exit my trade?
One thing is certain – Brutus has taken the guess work out of earnings trading for me.
I’ve changed my mind set and focus on repeatable patterns, so there’s no need for me trade earnings with 50/50 odds.
Earnings is kicking off this week with some big names like JP Morgan, Citigroup, United Health and others, and with the extra volatility the market is experiencing due to Fed policy and worldwide economic concerns, the next several weeks should be exciting!
If you’re willing to change your mindset about the best time to trade earnings, you can gain an edge over the thousands of option traders that consistently lose money by trading earnings the wrong way.
Until next time,
Tom Gentile
America’s #1 Pattern Trader
Topic for Wednesday, October 12, 2022: Earnings Trading
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