Great guest post by a new student of mine:
It would be great to always trade stocks on both the upside and the downside like this successfulstudent of Tim’s does:
…but sometimes you can only be somewhat sure about one direction. All stocks move up and down, but you cannot safely trade them that way. Even if you know the direction you might not know when and that can be a problem as well. It is not always possible to wait while the stock moves against you for the time that you are eventually right. This is especially true when shorting, since your margin account can only take so much of a beating before you are forced into your loss.
Download the key points of this post as PDF.
It is hard to know which direction earnings are going to go. Calling an earnings “beat” is very hard since there are so many predictions out there already. An earnings beat means beating the estimates. With so many it is unlikely that someone missed something. The deference given to estimates might be unwarranted, but there is no doubt that these people are trained to take into account as much information as possible.
If you are a long-term investor you can judge a company based on what you think the earnings will look like. That does not mean beating estimates but just meeting them and having acceptable guidance. Eventually it might pay off. For the short-term trader you need something with more ability to push the stock quickly. Seeing that ahead of time is very hard, because it takes both actual results and a prediction on sentiment. Telling the future regarding reality and how people will react is definitely unsafe.
However, once earnings come out things start to become far more predictable. You can watch a stock like any post-news momentum play. If the stock gets too hot too fast in any direction then it makes for a nice trade in the other direction. Corrections happen more often than not. A stock will only just continue if results were really that good, or that bad. Downside trends tend to be more robust than upside.
People are likely to take gains for fear of losing them, and are likely to take their losses for fear of getting more. That generally means that uptrends meet selling and downtrends meet selling. It tends to exacerbate negative trends while tempering positive ones. There are times when downtrends are met with buying, but this is most likely the minority situation. Can’t think of any empirical studies on the matter.
So instead of guessing at what the response from a major event will be you can look for an overreaction to the event and trade that. With enough experience you will find that it is far easier to read a trend that is underway with its own momentum than predicting a trend based on news that is extrinsic to the momentum. Indicators and charts will help you understand what the market is thinking, and even though you missed the primary trend you can catch the secondary correction.
Promotions are a bit trickier, because some are worthy of buying and some are all about waiting for a point to sell at. It takes a lot of experience to really figure out how to trade a promotion. When it comes to pump and dumps you always have the option of waiting for a peak and shorting it. Pump-and-dump promos as buys are really tricky and it is useful to follow someone that knows what they are doing.
You need to be quick on the draw for most promotions. Some are a slow-boil, but most are done quickly. The biggest ones have multiple periods of rising and falling, but these can get so risky as buys. There are not a set number of runs up. Penny promotions tend to be the worst. It is possible to have a promotion that involves a free newsletter but for a large stock.
I have seen mailers for Statoil (NYSE: STO) which is a oil and gas company owned mostly by the Norwegian government. A lot of these are teasers that want money in exchange for the ticker, but others are just free ones with the tickers plastered on it. These are still promotions. The person running them probably don’t have access to a ton of free shares given from the company. As many cloak and dagger stories there are around the corporate world and Wall Street there are plenty of things that big public companies cannot get away with.
Promotions of major stocks, which end up being more like marketing than the master plan of penny promotions, tend to follow a more traditional path. The momentum is created like how a sale at a retailer would create a rush of people coming to the store. This is outreach activity. You just need to be a good trader and knowledge of the trust paper more than email, hence the persistence of the hard mailer promo. Even email blast promos can move the stock by creating a lot of initial interest, though this moves far quicker that a mail promo. Since these tend to trade like normal stocks you would use normal trading guidelines. If it goes too far in one direction it might warrant shifting gears.going out. Mail is very old school but people tend to
The thing to keep in mind is that bigger stocks have lots of factors affecting the share price that has nothing to do with the promotion. The company might be a great one and the promotion might come at a time of great news, in that case a pullback might not happen. Or a mailer could be around a time of missed earnings and broken promises. Just keep in mind that there might be other factors that could throw a wrench into normal technical analysis, especially when it comes to things like pullbacks and bounces. Those are not guaranteed to occur. This is a rule that applies to technical and fundamental analysis, because in the stock market nothing is ever predictable all of the time.