There Are 2 Ways to Trade Earnings Reports. Only One Is a Real Strategy.
Most investors treat earnings reactions like a bet at the casino. Here’s the smarter approach.
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Market action is better on Tuesday, with breadth running about 58% positive. The chip sector (SMH) is improved but quickly pulled back from early highs. The Mag 7 names are mixed, small-caps are buoyant, and the Nasdaq 100 (QQQ) is up 1%, as I write. Biotechnology names are acting well on my screens.
One bottom-fish name I’ve added a bit to over the last two days is drone play Ondas Holdings (ONDS), which makes autonomous drones and wireless networks for industrial and defense customers. The stock topped at around $14 on June 2 and has been cut in half. It bounced Monday and is attracting more interest today. I have made a couple of buys and am looking to ramp it up once it proves it is holding support around $6.50. I have room for substantially more shares but there is no big rush.
Another name I’m looking to ramp up now that it is bouncing is Electrovaya (ELVA). I want to see how it closes before I make a move.
Two Ways to Approach Earnings
With Wednesday night an important day for major earnings reports, I want to talk a bit about the strategies and tactics you might use.
The most important issue with earnings reports is to be clear about your time frames and strategy. Earnings reports matter not only because they provide new information but because they create enhanced volatility.
The question is what you are going to do with that volatility. Are you going to trade it short term for some fast potential profits, or are you going to use it for positioning in the context of a longer term approach?
Why Betting on the Reaction Is Gambling
Trading earnings volatility in the short term is challenging. Most companies, especially bigger-caps, will beat the published estimates. If it were just a matter of rallying on a beat then it would be easy. The problem is that the estimates often have little relationship to actual expectations, and what makes it even more difficult is that no one knows exactly what expectations might be. They may be low or high but actually quantifying them is difficult.
Betting on the response to earnings is pretty much pure gambling. You may think you have some sort of special insight or edge, but you don’t. These trades are similar to a slot machine. You will win enough to keep you trying but over time you’ll likely lose.
Using the Volatility for Positioning
The second way to play earnings is for positioning. Rather than bet on the outcome, the goal is to use the ensuing volatility for new trades or positions. The initial reaction to earnings is often dead wrong and therein lies the best opportunity. A poor response to earnings for a stock with strong fundamentals is often a great time to ramp up position size. A euphoric response to a report may be a good time to take some profits.
Micron’s (MU) last report is a great example of the dangers of betting on earnings. It was an absolute blowout report with great guidance, but it was also a major top for the stock. The play was to lock in gains, and if you didn’t do that fast enough you paid a price.
There is much more to navigating earnings reports, but the great thing about earnings season is that it helps us identify new opportunities. I build a watch list of stocks with some of the best reports and then watch them for trading opportunities as the news is digested.
At the time of publication, Rev Shark was long ONDS and ELVA.
