3 Steps to Use Earnings Reports in Your Trading

Preparing for the earnings season involves selecting companies to focus on and conducting thorough research on the market before executing the trade.

Select Companies to Focus on

The first step is to select stocks to trade during the period. Traders are advised to go for a small number of companies, perhaps stocks they are familiar with or already trade, and to familiarize themselves with their earnings release dates. Large bellwether stocks are worth investigating, whether traded or not, as their results may affect broader sectors. When deciding which stocks to choose, investors should understand that the relationship between an earnings result and subsequent price reaction is not always direct. While better-than-expected earnings are often bullish, they don't always translate into immediate price appreciation and vice versa.

Do Your Research

Doing your stock research properly will involve looking at the estimated earnings for your chosen stock and how they compare to analysts' expectations. Also, investors should make sure to look at past figures to understand how the market has reacted to past announcements. While earnings season is often thought of in terms of what the results mean for a single stock, the season as a whole can also offer important takeaways. While information is presented on a company-by-company basis, common themes can always apply. Negatives such as coronavirus, geopolitical tensions, regulatory uncertainty or cyclicality can combine to create a wave of concern in a sector if they are mentioned often enough.

Create - and Follow - a Trading Strategy

Creating a trading strategy for the earnings season should include methodology for entries and exits, profit targets, time spent trading and a risk management plan. Trading earnings reports is difficult and risky. For some, trading during the event may not suit their risk profile. Therefore, any position taken should be adequately hedged and include a stop. However, volatility can create unique conditions that offer opportunities for several specific strategies. When building a strategy for earnings season, traders should be aware that quarterly gains can severely upset an ongoing price trend due to their relative infrequency and importance. This causes traders to position for severe price swings evidenced by high implied volatility.   When trading during the earnings season, there may be a period of uncertainty and extreme volatility ahead. This makes choosing the right stock, conducting thorough background research and smart risk management key to making it through the period as planned and implementing the right trading strategy. With these elements in place, traders can maximize their chances of success and carry some key insights into the next earnings season.