Every quarter a publicly traded company is required to report their earnings. An earnings report will often cause a huge spike or drop in the value of a company’s shares, as seen in the image below.
In 2015 Vivint Solar (VSLR) announced their quarterly earnings and saw an immediate 30% increase in share price that same day. Investors were impressed with the number of new solar installations shown on the earnings report.
Because earnings are so often followed by drastic price changes, many investors build their entire strategy around trading earning announcements. They play a high risk, high reward game, and those that win over half the time do very well.
Here are a few strategies, tips, and pointers, for beginners to learn how trade earnings on the stock market.
A company will typically release the date of their earnings well in advance of the actual release of earnings so investors can prepare. As a company’s earnings begin to draw near, market analysts will release earnings estimates that reflect their opinion of what the company should have earned. There are multiple places to find these earnings estimates. Here are a few:
Many brokers will also show how the company has done in previous earnings as compared to analyst estimates. Here is an example shown below. Note: All examples are done using the free TD Ameritrade Platform.
In the example above, you can see earnings estimates for Apple stock from 2014 to 2017. The green and red bars indicate the high and low estimates for that earnings release. The main gray bar shows the actual earnings amount for earnings that have already occurred and the average estimate for earnings yet to happen.The small green plus sign indicates that Apple beat the average earnings estimate that quarter.
You can use estimates to get a good idea on how to trade earnings by looking at past estimates and how close the company came to those. Some companies have a history of beating estimates almost every quarter. This means that there is a good chance that they will beat estimates again. You can buy stock in these companies before earnings are released and sell on the spike that (hopefully) follows.
Another way some investors will trade earnings is via the momentum they create. If a company announces earnings and they beat wall street’s expectations handily, there is a good chance that the company’s stock price rises for the next little while as investors continue to buy in, and fewer people are willing to sell. Some investors will keep track of companies that are announcing earnings in a given week, then try to jump in the moment the announcement comes out as positive.
In the example shown above with Vivint Solar, the company announced a great quarter, and after the initial 30% spike the price continued to rise for nearly 6 months. At one point the price of the stock had risen 100% from its lows.
Buy Them All
In 2012, CNBC reported that 7 out 10 companies had beat their earnings estimates. Since the stock price of a given company will almost always rise after a good earnings beat, some investors have found it profitable to just purchase shares of stock in all companies before they release earnings. Since the key to being a profitable stock trader is simply winning more than half the time, this trading strategy has proved very profitable for many traders. The key to being profitable in this trade is not putting all your eggs in one basket. There is not going to be a magic jackpot trade that boosts your portfolio 10-20% in a single day. Instead this strategy spreads out risk and brings about statistical gains.
See our types of stock market orders page to understand details of what a stop loss is. A stop loss will essentially immediately sell shares of stock if the price ever drops to a certain point. Understanding stop losses are important for understanding how to trade earnings. Many traders will use a close stop loss to trader earnings. They figure that if the price drops, their order will kick in and their maximum pain is their stop loss. If the price rises they can raise the stop loss and lock in gains, but hang along for the ride if the stock continues to rise.
The theory behind this is as follows. A trader may lose on 50% of the earnings plays they get involved in, but when they lose, they lose 5%. On the other hand, on the 50% of trades that they get right, they make 10%. Overall their portfolio is growing, despite losing half of the plays they involved themselves in.
Tips and Pointers
- If a company announces strong earnings, but the stock price seems to react in a weak manner, either not climbing at all, or slowly dropping, you should probably sell. When investors that are trading earnings realize that the effect of a win was not what they thought it would be, the selloff can often drive the price down. As the price drops stop losses will keep in and supply will beat out demand, dropping the price even more (see our lesson on stock price movements to understand this better).
- The second tip is to not chase. A young investor will often decide to hold off on earnings in a particular stock, then once the positive earnings are released and the stock price begins to climb, they feel the need to jump in. Don’t be the trader that buys stock at the very top of a price pattern and sells at the bottom.
- The reaction of the stock is the most important thing. The earnings can be great, and a stock may react poorly. The earnings could be poor, and the stock may react surprisingly well. Keep a close eye on reactions and it will give you a good idea of the strength or weakness of the stock.
- If you are trading earnings you will likely need to keep a close eye on stock prices that you are invested in. Earnings can push stocks to be extremely volatile and if you are not paying attention you might return to find you have lose all your gains and are in the negative.