The earnings season is the most interesting period for any stocks trader. It comes after every three months when firms release their quarterly earnings and do their earnings call.
This is the period when most stocks traders make a lot of money!
In this article, We will highlight the best way to trade during the earnings season.
Why earnings season is important
As forementioned, stocks traders are keen on each financial quarter’s earnings season. The period, which lasts for a few weeks, gives insight into how various large companies are performing.
A company’s earnings report includes
- net income
- EPS (earnings per share)
- outlook of the remaining quarters and the overall financial year.
The earnings season keeps traders informed about the companies on their watchlist, as well as the corresponding index. For instance, Apple is one of the large companies encompassed in the Nasdaq 100 index.
As such, when the firm records significant growth in its earnings report, traders are likely to be bullish on the index.
Key data to watch as a day trader
A company’s earnings report encompasses an array of figures. As a day trader, some of the crucial data that you should look out for include.
This section highlights the amount of funds the firm obtained from sales (revenue). It also comprises the net income, which is the earnings after the deduction of expenses. From these figures, you will be able to gauge the income of the company currently and in the next quarter.
It highlights the firm’ financial health at a particular period. The figures show the amount the firm owes and owns. Subsequently, one can tell if the entity is in a good position to pay its bills.
The embedded numbers include the shareholder equity, total liabilities, total assets, and short-term liabilities & assets.
Cash flow statement
This part of the earnings report focuses on the cash in and cash out. While it does not carry as much weight as the balance sheet and income statement, it is still important for a trader to understand where a firm’s finances are coming from and going to.
How to trade earnings season
Companies, Date, and time
First, you need to know which companies are releasing results during a particular day and what time. Companies usually release their results before, during, and after the market opens.
To become a successful trader during this time, you must know this so that you can place your trades accordingly. This information is freely available in several websites like investing.com.
You should now look at the results investors are expecting. Before a company releases its results, Wall Street firms predict the revenue and earnings per share (EPS) that the company will have.
They predict this using their models and the company’s past performance. You will find these numbers in the Earnings Calendar.
The rule is that when a company misses the estimate, chances are that its share price will fall. Therefore, you should always consider looking at the expected results.
Sometimes, a company’s stock price will fall even when it releases excellent results. This happens because investors look at other things besides the headline numbers.
While the revenues ans EPS are usually important, they are lagging numbers. This means that they tell investors what has already happened. Investors on the other hand are known to look forward.
For instance, they look at a company’s guidance and whether it is reaffirmed or changed (downwards or upwards). Investors buy companies because they expect to benefit in its growth.
Therefore, if a company’s guidance shifts downwards, chances are that there will be a sell-off. If it guides upwards, investors will likely buy more shares.
In other cases, they look at comp sales. This is more in the retail and restaurant sector. In this case, a company can beat on revenues and EPS but if its comp sales are on the decline, investors will exit.
Another metric to look at especially in technology companies is the number of active users. For instance, Twitter recently released its results which showed declining revenues. However, the company’s stock went up as the company added more users in its platform. Therefore, you should look at these things.
When trading an earnings report or season, it is also crucial to evaluate the fundamentals that are likely to influence the stock price.
For instance, changes in supply and demand around the time of the earnings release tend to be influential aspects. Besides, if the central bank makes changes to the interest rates, a trader may have a clearer picture of how the stock price will move post-release.
The earnings season provide analysts with a good opportunity to upgrade or downgrade their stocks. They do this because of the latest news that companies release.
While the credibility of the analysts calls has been questioned, investors tend to pay a close attention to them. Whenever they release their calls, the stock price tends to gain or lose.
It is also important to look at comparable companies. This is because most companies usually follow the same trend. For instance, if an investment bank like Goldman Sachs reports increased trading revenues and increases its guidance, chances are that its competitor, Morgan Stanley will have improved numbers. Therefore, if Goldman’s numbers are good, you can buy Morgan Stanley.
However, this does not always work. Some years ago, while all the major banks saw increased revenues, Goldman saw increased revenues that missed earnings forecasts.
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Protect your trade
In stocks trading, volatility is usually very high during the earnings season. This is because this is the period when investors make the decision of buying, holding, or selling their stakes. Therefore, it is very important to protect your account by having a stop loss in every trade that you open.
The point that you place your stop loss should be where you feel confident that the money you lose will not hurt your financials. Like We have mentioned before, as a trader, you should carefully evaluate your risk-reward ratio.