Traders look forward to earnings season as it tends to produce increased volatility in individual stocks as well as a crop of new opportunities. The next group of market leaders becomes apparent as they issue strong reports and increased guidance. The stocks with the strongest reports make for a great watch list in the months ahead.
While earnings reports will help us find some new trading ideals it also carries very high risk if we don't deal with the news carefully. Market players are often prone to believe that they have special insight into how a stock will react to earnings when the truth is that it's just a roll of a dice. Since it is basically a 50/50 bet, it is easy to be right on a random basis but that shouldn't be extrapolated as being some sign of great insight or skill.
Earnings are high risk because not only is it necessary to predict what the numbers might be but it is even more important to understand the level of expectations. High expectations may result in 'good' reports being sold while low expectations may result in 'bad' reports being bought. However that is what leads to the best opportunities
The most important thing to remember about trading earnings is that you do not have to hold a stock into its report in order to find good trade entries. Most of the time there are many good entries - with reduced risk - after the report.
If a company has issued a good report and is being discovered by the market it won't immediately price in the increased expectations. The movement will be incremental and there will be a new group of traders and investors pursuing the stock as it develops. The character of the action will shift and that is what will create entry points.
In some markets very strong reports see straight up moves and continued momentum but in more difficult markets - like what we have now - there tends to be pullbacks and entry points as the news is digested and the market starts to understand the story. It is not necessary to chase entry points out of fear that a stock may run away.
The best approach for buying earnings 'winners' is to start small with a 'tracking' position and then watch to add as the chart develops. Additional entry points aren't always easy but if you move slowly with small buys you don't have to have ideal setups. You can put money to work gradually and still have an opportunity to take advantage of subsequent chart development.
I am often surprised, when I look back at the best reports from the last quarter, and see that a stock with a great report hasn't moved much or is trading poorly. It is often due to market conditions more than fundamentals but these stocks may offer good trades as expectations build for the next report.
If a stock beats estimates substantially in the prior quarter there is an increased likelihood they will beat substantially again. This expectation may not be priced into the stock so there could be some potential there.
One stock that has caught my eye recently is ehealth (EHTH) which primarily brokers Medicare Advantage health insurance plans. The stock has been hit hard on worries about 'Medicare' for all that is proposed by Democratic presidential candidates but in its last quarter it substantially beat revenue and EPS projections and had a very upbeat conference call. It is scheduled to report on October 24. This is a seasonally weak quarter for the company as it awaits the Medicare enrollment period but it had strong operational momentum last quarter and there is a good likelihood that may continue. I wouldn't want to hold a big position into the report but it is likely to have some interesting volatility before and after the report.
Earnings season provides great opportunity but the key is to stay cognizant of and to manage the risk. Don't be a gambler that bets on the numbers. Be a speculator that trades the expectations and reactions.
