Today’s Trading Lesson From TradingMarkets

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How To Use TM’s Indicators: Stocks That Rose On Worse Than Expected Earnings

By Daniel Beighley

If good news sends a stock down, what’s going
to send it up? The focus of this lesson is a little gem on TradingMarket’s
“Stock Indicators” page under “Actionable Signals & Other Indicators”:


Stocks That Rose On Worse Than Expected Earnings,
and


Stocks That Dropped On Better Than Expected Earnings.
Simply put, these alerts give setups with good
risk/reward characteristics.

Earnings
are the underlying force of stock valuations, and nothing will change the
direction of a stock faster than earnings-related news.  Surprises in earnings
reports almost never fail to make or break price action, and many traders won’t
even take a position in a stock the day of an earnings announcement because it
might drastically alter its trend. On the other hand, when alerted to price
action divergence from earnings news, the astute trader can take advantage of
certain situations.

A stock
that rises on worse than expected earnings, or falls on a better than expected
earnings, is telling you something is out of place. Whether it be institutional
interest or a  less obvious agent, is not so much an issue as the fact that the
stock traded against the news.  When analyzed in conjunction with technical
analysis, this divergence has the makings of a profitable setup for a swing
trade, or even a longer-term trend reversal.

When it
comes to interpreting market news for the sake of profiting, many of us have
experienced the madness that comes from illogical price swings, and seemingly
irrational behavior. As Larry Connors elucidates in

Street Smarts, we need to listen to what the markets are telling us.  A
stock that rises on better than expected earnings is saying, “This may be bad
news, but I don’t care!” Just because it seems natural for a stock to rise on
good news in no way means that this will happen. The reverse is true of a stock
that falls on good news. The price action is what we should focus on.

Below are
four recent examples of stocks that acted counter to what their earnings
announcements suggested. As one might expect, these alerts can be few and far
between, and in keeping with reality, one of the examples illustrates a setup
that didn’t  work out. Nothing is ever a sure thing in the markets, though what
we aim for is at least a good risk-to-reward ratio.

 

Example 1:
Research in Motion (RIMM)

In our first example, we have Research In Motion
(RIMM)
announcing earnings of 8 cents a share, worse than analysts had expected. As you
can see, the stock didn’t seem to mind, and began an uptrend stemming from that
news event. Combining a little bit of bar chart analysis with this news could
have comfortably positioned a trader in this stock for a nice gain. The day the
news was released, a trend reversal in the daily bars set up, as the price
action moved higher than the previous two trading days ranges. If you were to
have went long the day after the report, at least a 2 point gain would have been
made in six trading days. A stop loss should have been placed above the high of
the daily bar of the news release.

 

Example 2: Shuffle Master (SHFL)

H

Here is an example of an alert that
didn’t work out. When Shuffle Master announced earnings of 63 cents a share,
worse than analysts had expected, the stock initially rose. Unfortunately it did
not make a trend reversal, and a long position off the alert would have been a
loser. The next two days of trading, despite some upward momentum, produced
tails on the daily bars, giving warning of some weakness in the stock. If you
were to have used a stop loss below the low of the day the news event was
triggered, you would have been out with minimal damage. Using technical analysis
to aid in your decisions is definitely an advantage. Some traders may have
avoided the setup as the gap down was a sign of weakness, though even the best
of us put on losing trades.  The intention of this example is to educate.

 

Example 3: Apollo Group (APOL)

APOL announced earnings of 27 cents a share,
beating analysts’ expectations by a penny. The initial reaction to the news sent
the stock down. An astute trader may have taken the opportunity to short the
stock as its daily bars were also suggesting some downside momentum. Note the
ominous tail leading into the news day’s expanded trend reversal bar. An short
entry  on the day after the news release would have made at least 3 points in
nine trading days.  A stop loss, placed just above the bar of the news release
day, would not have been triggered.

 

Example 4: Solectron (SLR)

SLR announced earnings of 8 cents a
share, beating analysts expectations of 5 cents a share. From looking at the
chart, we can see the stock gapped down the day before the news release, giving
an indication of weakness. An entry on the short side the day after the earnings
report would have quickly turned into a winner.  A stop loss should have been
placed above the high of the daily bar of the news release. In this situation
scaling out of the position would be a great way to take some profits. For some
great swing trading and money management strategies take a look at

Dave Landry on Swing Trading. 

Trading against
the logic of a news event is something many traders are uncomfortable with.
When analyzing news events, we need to keep in perspective “what is,” instead of
“what should be.” Getting caught in the emotions of news stories can often spell
trouble for traders, but with the right mind-set these events can be profitable.
The earnings alerts on TM’s “Indicators” page, should be viewed as invitations
from a stock to act counter-intuitively, and avoid some of the common pitfalls
that “the herd” mentality will get a trader in.
What seems like stepping in front of a train could
be your next ticket to a winning trade.

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