Trading 101

Article #6: Earnings

One of the most commonly used indicators for companies’ conditions are the earnings reports. Playing earnings is very popular among the traders because this setup is giving you additional support that the position is going in your way. That’s why in this article I have decided to give you more details about what exactly the earnings are, how we can benefit from them, and with what we have to be careful in this setup.

• What are the earnings?

When a public listed company announced their so-called earnings, they are reporting the profit that the company made for the set period. Earnings are mostly announced at conferences and are presented to the public in a report form. The time set is usually quarterly or monthly, and the reports are published after-tax earnings per share (EPS). The EPS are most commonly weighted against the forecast of the analysts.

• Why do companies have earnings?

The earnings announcements are used by the companies to show how they are doing from a profitability standpoint. Furthermore, a lot of companies are posting plans for the future what the earnings growth is expected to be, based on the upcoming projects. And of course, if the actual results are worse than expected into the reports could be included reasons why the company missed the profit target.

• What is the risk?

Whenever you get involved in such type of investment, there is some risk that you need to calculate as additional to the market risk. First and most important thing is the detailed research of the company: what is the possible future outcome of their development and what is the overall situations of the sector in which the company is operating. Second, comes the risk of significant mismatch from the forecast. In case of a hidden problem with the company, there is small chance for actual results to be way different from the estimates. In this case, the main risk comes from the fact that it is almost impossible to calculate and place your stop correctly. And third, comes the pricing which is strongly related with the first risk that I mentioned above. If you haven’t done detailed research on the company and you are not tracking the share price long enough on a daily basis there is a chance to miss the fact that the movement is already gone, the earnings reports are priced, and the report won’t have that much of an effect of the price or in the worse case it will have counter-effect of the price.

• What can we gain?

In case of proper development of the trade, the possible gains are enjoyable. After well-made research, you can catch the movement in the beginning and hold it with more confidence because you have more edge. Again, based on the analysis you can estimate what is the fair share price and try to close it on maximum profit even before the actual EPS report. And last but not least if the trade is developing as you were expected and according to your research there is still room for the movement to continue you can push with the amount of the exposer on that particular position — increasing the risk due to the higher probability of the trade to become profitable.

• How to play them?

The EPS reports are pretty much the same as all the other news which makes them the most important indicator — worse or better than expected. You can try to play the shares movement based on that and the forecast. The other way is the look for companies which are unstable and to speculate with the EPS report. Which means to play it the other way around with the idea of the actual results to be very different from the forecast. This could bring you more and quicker profit; however, it is less probable to happen and way riskier.

• How to protect our capital?

The best advice which I can give you here is to play only well know companies and to base your decision on well-prepared research. Otherwise, you are decreasing your probability of hitting the perfect setup. Also, if you are in the trade during the actual announcement of the report you need to take into consideration that the volatility is going to be higher and your stop needs to be wider. And after the noise goes down and the volatility decreases if the trade is still not going in your direction you might exit before it reaches your stop.

Based on this article you can try to develop your own strategy for playing the EPS reports applicable for your trading style. It is always good to try new trading setups because you will never know which one will bring you the most profit. And those are the basis on which you can start gaining experience.

Written By Valentin Fetvadzhiev

18.04.2018