Third-quarter earnings season shifted into high gear the past week with highly awaited results from tech titans Netflix (NFLX) and Tesla (TSLA). This is the time when stock market leadership fully reveals itself, as investors react to the results.
Earnings reports cause many of the largest moves in stocks, and they require special care. Strong earnings can fuel top stocks to previously untouched levels — and above new buy points — while a less-than-impressive announcement can send shares tumbling.
Companies disclose their earnings reports four times a year, some weeks after the conclusion of each quarter. The quarterly reports offer investors an opportunity to examine how the company is performing at a detailed level. From there, analysts and professional fund managers use that information to project the company’s future earnings and sales growth and create price targets for the company’s stock price.
The stock market’s reaction to an earnings release can often tell you more than the earnings themselves. If the results seem strong but the stock slides anyway, investors may be concerned about the sustainability of growth, rising costs or a myriad of other potential negatives.
Conversely, weaker-than-expected results with a positive stock reaction could mean that the company’s future is bright despite the unexpected weakness.
How To Trade Stocks Into Earnings
With the stock market back in a confirmed uptrend, as a result of the Oct. 14 follow-through day, investors should now be looking for stocks to buy that are breaking out past their correct buy points in heavy volume.
Investors know they should buy stocks on the breakout day, but what if earnings are soon after the breakout?
While there is no hard and fast rule to follow, there are a couple different strategies to help mitigate risk ahead of the earnings release.
One is to buy half the normal number of shares on the breakout. That way, if the stock reacts positively on earnings, you can complete the position with a lower average cost than if you had initiated the entire position post-earnings. Conversely, if the stock sells off, then you can sell the shares with a smaller loss than otherwise possible.
Two, you can use IBD’s earnings options strategy. In 2016, IBD introduced an options strategy to limit risk around earnings. The strategy provides a way to capitalize on the upside potential of a stock’s move around earnings, while reducing the risk of a negative reaction. Weekly or monthly options can be used — so long as the cost for the option is right.
Breakaway Gaps Can Lead To Even Bigger Gains
With earnings season in full swing, investors should be closely watching top stocks over the coming weeks as they report their financials. A positive result could trigger a breakaway gap. That occurs when buying demand heavily outstrips supply at current levels, sparking a big rise in share price.
A quintessential example of a breakaway gap occurred on March 28, 2018 in shares of Lululemon (LULU). Shares surged more than 9% in big volume after the company’s stronger-than-expected earnings and sales. The stock briefly traded at the 83.41 buy point, and closed in the 5% buy area. The stock became extended the next day.
Over the next seven months, Lululemon would advance as much as 97% before its next base formation.
Sometimes, a stock gaps up so hard that it doesn’t trade within 5% of the proper buy point, you want to wait for the high price of the first five minutes to appear using an intraday five-minute chart. Buy shares as close as possible to that price, as the stock moves past that level.
How To Trade Stocks: AMD In Buy Range Before Earnings
Chip leader Advanced Micro Devices (AMD) broke out past a double bottom’s 114.59 buy point Monday and is in the 5% buy area, which tops out at 120.32. Bullishly, the stock’s RS line is at recent highs, reaffirming the stock as a market leader. According to IBD Stock Checkup, AMD boasts a perfect 99 IBD Composite Rating.
But don’t get too excited yet. The company’s earnings are due out Tuesday after the market close. Analysts expect the company’s earnings to jump 61% to 66 cents per share on revenue of $4.1 billion. Those results will be a decisive factor in the overall success of the breakout.
Be sure to follow Scott Lehtonen on Twitter at @IBD_SLehtonen for more on growth stocks and the Dow Jones Industrial Average.
YOU MAY ALSO LIKE: