Earnings Season: Reward And Punishment In The Stock Market

08/16/13 12:45:46 PM

by Billy Williams

At times, the stock market is upside down when good earnings make stocks plummet and bad news makes stocks rally, but if you know three things to look for, you'll pick more winners.

Security: KORS, AMCX
Position: Buy

As earnings are being reported, you'll notice that some stocks are rewarded on lackluster results while other stocks seem to be punished for achieving superior results. This can be incredibly confusing for traders who painstakingly pour over annual reports and price charts to pinpoint the stocks that have the highest potential to outperform the market based on the strength of their earnings alongside their compelling price action but end up either with losses or inferior gains. The stock market comes across as schizophrenic and leaves you frustrated and questioning whether you should be attempting to trade stocks at all.

In trading, over time, you come to learn and accept that the devil is in the details especially in stock selection.

You see, there is another game going on behind those annual reports and price charts that you don't see but once you do then it makes it easier to know which stocks to avoid and which ones to commit your capital too.

First, understand that big earnings attract big attention, particularly from the institutional investors.

They have the size and scope to move the market but also to employ the best and brightest analysts in the world to help them pick the best of the best in stocks. Analysts are graded and promoted based on their ability to pick winning stocks and employ all kinds of sophisticated financial models to help them determine which stocks are going to outperform all others.

So, they have a serious vested interest in picking the right stocks.

That said, the stocks that have the highest earnings garner the most attention because their earnings reports are the best indicator on whether they are going to the next growth leaders.

AMC is trading up through resistance out of a First Stage Base pattern in advance of earnings being announced. Price action suggests that analysts are already calculating positive earnings reports so it is vital for you to watch and see how the stock reacts after the announcement.

Graphic provided by: www.freestockcharts.com.

In addition, a company's managers can offer guidance as to how a company will perform in the future. This is the only legal way that managers can communicate their vision of how their company is going to perform and it has tremendous sway over Wall Street, investors, and especially, analysts.

If a company that is being followed by a group of analysts gives guidance that it will achieve .50 earnings per share and then later report a surprise of .55 earnings per share, there are three specific reactions to watch for - the initial response, subsequent resistance, and resilience.

In an initial response, you have to take notice as to whether the stock rallied or sold off. If it rallies, then analysts were truly surprised and instructed traders to dive into the stock and take a position or add to existing positions.

If it sold-off, then though the company issued a surprise earnings of .05 higher than expected, analysts were disappointed because they were expecting a better earnings report.

KORS broke out of the Handle portion of the Cup & Handle pattern prior to a successful earnings report by the fashion designer on 8-6-13. Price sold off slightly the next day so you want to see how the stock resists any selloffs and profit-taking and use pullbacks as a buying opportunity if it holds up well.

Graphic provided by: www.freestockcharts.com.

Resilience pertains to how quickly the stock recovered. Did it fail to rally after a pullback or did it sell off unexpectedly? This is critical when you notice that the stock formed a chart pattern that issued a buy signal in the weeks leading up to the earnings report. At some point during the lead-up, the future prospects of the earnings release were factored in and represented by the bullish price action in the form of the price pattern.

You have to watch closely to see how price moves - traders/investors might lose confidence at higher price levels or their confidence may grow, which means they will hold on in the anticipation that the stock will go higher. Either way, it will help you to have a strategy in place.

Earnings reports are the lifeblood of the stock market and investment decisions that impact trillions in capital are riding on those reports. For you, knowing when and where to watch for price to react can give you a big edge in narrowing your stock candidates to the select few that can emerge as tomorrow's leaders and avoid the non-performing stocks.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

Company:	StockOptionSystem.com

E-mail address:	stockoptionsystem.com@gmail.com
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Earnings Season: Reward And Punishment In The Stock Market

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