5 Tips for Successfully Seizing Earnings Report Opportunities

Nothing is more important in determining the long-term value of a stock than earnings. Four times per year, we are provided with insight into how a company is performing, which often creates a burst in volatility and may completely change our view of the stock.

Far too many traders treat earnings news as an opportunity to bet on whether a company will exceed published EPS and revenue estimates. The majority of stocks exceed their published estimates, but there is typically a "whisper number" that reflects actual market expectations.

The whisper number is just a general guess based on history and other clues provided by management, and it will vary and shift quite a bit. It is the whisper number that will determine the reaction of a stock to earnings far more than the published estimates.

Knowing what the market is expecting with some precision is nearly impossible, and that is what makes betting on earnings reports so difficult. Not only do you have to be right about beating published numbers, but you also have to be right about what the market is expecting.

The great thing about trading earnings reports, though, is that there is often a very good opportunity to trade the volatility after the numbers are released. There might be an up or down gap on the news, but that is almost always followed by more big moves. Therein lies the opportunity, since you are in a better position to manage the risk rather than a straight bet on a binary outcome.

Here are some important issues to keep in mind:

Context and time frame are key.

The manner in which you handle earnings will vary greatly depending on whether the stock is a longer-term investment or a short-term trade. Day traders may want to focus on trading post-earnings volatility, while longer-term investors may be more willing to hold a position for the report and then adjust their position size depending on the news. The important thing is to be clear about what you are doing and to have a plan, regardless of the outcome.
Don’t count on the chart to predict the reaction to the report.

Standard technical analysis doesn’t work very well when earnings reports hit. Ideally, a big run up into a report would suggest a strong report, but in many cases, the run up creates conditions for profit taking on good news. A stock that is acting poorly in front of a report may actually have a better chance of a positive reaction because expectations are low, but the standard rules of chart reading are often turned upside down.
Conference calls may be far more important than the number.

The reaction to the report may shift sharply as management provides further information and context during the conference call. Guidance will be key and may turn a good report into a poor one or vice versa.
Focus on trading the reaction rather than trying to predict what the numbers might be.

The market will not instantaneously and accurately reflect all of the information that is presented in an earnings report. It will take a while to understand the impact of the report, and there will be a lot of noise created by short-term traders who are trying to catch quick moves.
Earnings will likely be the best time to adjust the position size of longer-term investments.

Earnings will help to confirm whether your investment thesis is right or not and provide confidence for expanding or contracting the size of your investment. I own a number of stocks, which I believe are good long-term investments. If third-quarter earnings reports confirm my thinking, I will look to expand those positions.

The best thing about earnings season is that it helps new leaders emerge and is great for stock picking. We should have plenty of great trading opportunities in the next few weeks, regardless of what the indices may do.

At the time of publication, DePorre had no positions in any securities mentioned.