For investors the middle of earnings season is a time of volatility and uncertainty. It’s not unusual to find stocks that have either gapped up or gapped down on high volume.  A few of our clients have called in to ask how to better handle this type of volatility, and if there is any way to predict what a stock will do when it reports earnings. I figured this would be a great time to explain what happens during this time, and how we at MarketSmith handle our positions when they are close to reporting earnings.


First, always make sure that you know when your stocks are reporting earnings so you have time to decide what to do before the stock’s reaction to earnings takes place. 

 

On the daily charts in MarketSmith, you will find the earnings report date, as reported by Thompson Reuters, in the bottom right-hand corner. The red asterisk will indicate if earnings are expected to be reported within the next four weeks.

 

But then the question is: What to do?

 

The reason it is difficult to predict the outcome of the earnings report is because the result often has little to do with the actual numbers. It has everything to do with shareholders’ reaction to those numbers.

 

The stock market is human nature on parade…” – Bernard Baruch

 

We have seen this many times. A company reports earnings, beats estimates, but then an executive uses the wrong choice of words on a conference call and the stock gaps down 8%, or more.

 

Taking any action around an earnings report depends on where you entered the stock, because that determines your level of risk. If you have a profit cushion on a stock heading into earnings, the risk/reward ratio typically is in your favor.  You can take a small loss without being down on the stock.  Much riskier is buying a stock right before the earnings report, or holding a stock into earnings with a loss. In our shop, we rarely, if ever, do either of those things.

 

To gain more insight on various types of price gaps, listen to our archived webinar from 4/22/14: “How to Handle Stock Price Gaps,” with Irusha Peiris.

 

 

 

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