When a company reports earnings, traders react quickly, sometimes moving the stock 5, 10 even 20% immediately. The initial move after the earnings report can be the biggest move of the year, so investors need to be keenly aware of what exactly is happening...and why.
However, there is an odd trend emerging.
Too often we find that companies beat their earnings expectations, but the stock still tumbles down. This is downright baffling making the next move for investors all the more confusing.
I want to shine a light on the 4 reasons why this scenario happens. Even better, I want to give you a way to profit from these events in the future.
1) Big Money and Liquidity
Liquidity is measured by the number of buyers and sellers in relation to the stability of an asset's price. If a stock can easily be bought or sold without moving the price, it is known as "liquid". If a stock move is volatile and sees a large percentage move with a small amount of trades, it is known as "illiquid".
Big hedge funds and money managers need to enter and exit stocks carefully because of liquidity issues caused by computer driven trading. Because they have a great number of shares, they can influence the movement of a stock easily when they buy and sell.
Rather than knocking a stock down when it is inactive, they look for opportunities when there is volume. If the money manager wants to exit a big position, they wait until they know buyers will be there to support the stock. When a company has a good earnings report, buyers show up in the stock and a position can be unwound.
When the new buyers run into selling from large funds, they are quickly out of the money and take losers as the stock continues lower. This domino effect causes a sell-off that creates a single day panic, which can lead to a 5-10% down day.
More . . .
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2) High Expectations
"Priced in" is a phrase commonly used in the world of investing as a company approaches an event. An event could be earnings, company news, a product announcement or any other market moving catalyst.
As it approaches, the market prices in the event by moving towards a specific price level. When the event news comes out, a stock shouldn't move much, because the news has already been anticipated by the market.
When it comes to earnings, if the expectations are already high, the stock has most likely priced in an earnings beat. At this point a stock is vulnerable to a sell off if they don't blowout the quarter. Even if a company beats expectations, traders will take profits as upside is limited. This selling can lead to panic by ordinary investors, which can cause them to exit the stock prematurely.
3) Option Premium Sellers
The options market is a gamble before earnings reports and market makers know it. Retail traders will buy put and call options betting on a big movement after an earnings report. However, the premium sellers (market makers) on the other side of the market want those options to expire worthless.
When earnings come out, premium sellers will manipulate the stock lower, so the call buyers don't make money. They can achieve this by aggressively selling the stock down, knowing the lower it goes, the more money they will make.
4) High Frequency Trading (HFT)
The three factors I talked about above are all enhanced by High Frequency Trading. They use high speed computer algorithms to push stocks down to irrational levels by shorting stocks. When they recognize the selling has dried up, they cover their short position and then buy the stock at a lower price to profit when it bounces back.
Due to the speed of the algorithms, a day trader stands little chance against the HFTs. However, short term investors can benefit if they buy the dip and have the patience to hold for the bounce.
How to Capitalize
By utilizing the Zacks Rank, an investor can separate the real blowups versus the temporary sell offs. Not only will the investor buy a stock at a discount, but they will also position themselves for longer term percentage gains.
You may not know how to spot these earnings moves...but I do. It comes from spending 12 years as a professional trader and watching how markets move and react to news. The next month has a lot of companies left to report earnings, so why not profit from the wild earnings moves?
I manage a portfolio called Zacks Counterstrike that is designed to sniff out when the computers have made a short term mistake. We take advantage by snapping up quality stocks at beaten down prices looking for quick rebounds. Or sometimes short the stocks of weak companies that have seen price spikes that make them ripe for a fall. When these stocks have moved our way, we lock in gains and look for the next trade.
If you're interested, you can follow my Counterstrike picks, along with all of Zacks' real-time buys and sells for the next 30- days as part of our see-everything Zacks Ultimate program.
The upcoming election is another timely buying opportunity I can help you capitalize on. I created a 2016 Election Stock Report to help investors zero in on a handful of stocks likely to skyrocket after Election Day: 6 to own if Hillary Clinton wins, 6 if Donald Trump wins.
This report is absolutely free for Weekend Wisdom readers who look into our Zacks Ultimate program no later than midnight on Sunday, October 30.
Wishing you great financial success,
By Jeremy Mullins
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