What is your policy or strategy concerning plays that have a close earnings date? (January 14, 2014)
Stocks with approaching earnings results offer opportunity and risk. Depending upon the overall market's status earnings season can receive different treatment from investors and traders. A market that is trending higher but is down taking a test or consolidation ahead of earnings season can enjoy a run to the results and some upside after results. If there is no pre-earnings run, earnings surprises can trigger a new round of buying. If stocks have put in a run ahead of earnings they are susceptible to selling on the news even if earnings are solid as the earnings news is to some degree priced in ahead of the actual releases. Thus we always take into account the overall market position in determining plays we pick and participate in as earnings season nears. Some stocks are leaders and make their own wake regardless, but most stocks are followers, following the general market's direction.
With respect to initiating plays on individual stocks, we typically do not like to trade around earnings, at least holding through earnings. There are instances where we will hold a position through earnings, but typically it is a position we already have in place for some time and there is no timing concerns related to options. A stock in a well established trend we are holding for the longer trend run fits this category. Even so, if a stock has rallied well into the earnings result we will consider banking a portion of the position simply because taking partial profits at logical points after strong runs makes sense in terms of money management and getting the most bang and return for your investment dollars.
When initiating new trades or position trades around earnings we look at a few scenarios. Our favorite: trading post earnings. The news is out, the stock has reacted, and we can counter punch off of that move with MUCH more certainty as to direction because we only play patterns that have a high probability of success. With the earnings question removed and the response gauged in the stock we can enter new plays up or down. For example, a stock that gaps on the earnings is a prime candidate for a post-earnings play. A breakaway gap tends to run in the direction of the gap and when it has set up properly and shows the next phase is starting, we move in. We made a lot of money on AMZN coming out of the last bear market in such a manner. PCLN, NFLX and other huge winners showed this gap action and we got in and enjoyed great gains. Even if a gap is not a breakaway gap it can be played as a gap fill, after the gap fill, etc. Many opportunities open up after earnings, not to mention the situation where a stock reports earnings and continues working on the same base. When the base is complete you know it is going somewhere.
There are times we initiate pre-earnings plays in an attempt to capture a pre-earnings move. The stock is typically well-positioned in a pattern that leans toward an explosive near term run, often after a test of near support (10 day EMA, 38% Fibonacci retracement) during a solid ongoing move. Some stocks have a propensity to make pre-earnings runs as well, particularly if the technical pattern is set nicely. On those stocks we can enter the play, but knowing that our intention is to be out OR take a substantial portion off of the table before earnings regardless of whether we have a gain accrued or not. Responses to earnings can be guessed at given a stock's technical pattern ahead of results, but it is just guessing and we like to remove as much supposition and guessing from our plays as possible, stacking the deck in our favor with technical patterns, decent fundamentals, market leadership characteristics, volume, etc. Those are quantifiable; reactions to earnings are not. Thus, great patterns get us looking at plays to run into the earnings release, but typically we do not hold through results unless we have a specific reason, e.g. maybe a split announcement or the way a particular stock reacts to earnings in this particular situation. Even then earnings are a fickle mistress, either rewarding you big or slapping you hard.
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