Thursday, July 24, 2014

4 ways a speculator can play earnings, Kevin Marder

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About Kevin Marder

Kevin Marder is a guest columnist and a co-founder of MarketWatch. He is principal of Marder Investment Advisors Corp. and a contributor to The Gilmo Report. Previously, he served as chief market strategist for Ladenburg Thalmann Co. and developed institutional fixed-income risk management software for Capital Management Sciences.
By Kevin Marder
A generally good earnings season has allowed shares to emerge from a three-week consolidation.
The Nasdaq Composite's COMP -0.03% technical pattern resembles a miniature double-bottom, with its characteristic "W" outline.
All charts created using TradeStation . ©TradeStation Technologies, 2001-2014. All rights reserved.
Leading the way higher is the Naz, an outperformer for the past four outings. Inside the Nasdaq, technology bellwethers like Microsoft MSFT -0.97% and IntelINTC -0.85% do the heavy lifting, boosting the Nasdaq 100 QQQ -0.06% at the expense of smaller issues.
About two-thirds of the market's leading stocks are due to report earnings between now and Aug. 8. As noted here recently, there are a few different ways for a speculator to play the quarterly earnings season. One way is to stay out of those names that are expected to report, regardless of how attractive they set up technically.
Another is to take a junior-sized position in a stock that otherwise fulfills the requirements of an attractive pattern setup. A third would be to use an option contract to hedge a long position in a name ready to report earnings. A fourth would be to reduce the time frame from intermediate-term (weeks to months) to swing (days). With this last alternative, the potential return would also be reduced, as the position would be exited ahead of the earnings release.
Words to the wise: Using a stock's behavior during the day or days just before an earnings report as a clue to what it will do post-report carries the risk of being completely wrong.
As one example of this, Facebook FB +5.74% looked to be in a solid uptrend leading into its earnings report, as the below chart shows. Of note was Wednesday's 3% rise on volume 78% above normal. After Wednesday's close, the stock unveiled its earnings report and, sure enough, the stock rose to 75.22 from the regular-session close of 71.29.
Yet TripAdvisor TRIP -6.14% , shown in the below chart, also looked to be in a solid uptrend going into its Wednesday report which came out after the close. Whereas the stock closed the Wednesday session at 107.36, it fell in after-hours trading to 95.50.
How does one distinguish between two otherwise healthy lead-ups to an earnings release?
The answer: One doesn't.
The basic rule of speculation/trading is to only take positions when the reward-to-risk ratio is skewed in one's favor. Coming into an earnings report and its status as a wild-card event, it is not possible to have a beneficial reward-to-risk profile. Too much is left to chance. This means a speculator's edge is gone.
Among the names, Chipotle Mexican Grill CMG -0.16%released earnings earlier in the week, precipitating a powerful breakout that resulted in Tuesday's 12% move on 444% more volume than normally seen in the restaurant operator. Earnings estimates were most recently revised upward, such that most Wall Street analysts eye growth of 30% in 2014 and 27% in 2015.
Combine this heady rate of growth with a history of high earnings stability (7% annual standard deviation over the past few years, quite high for a bona fide growth stock) and deep liquidity (average daily dollar volume of $300 million), and you have an institutional favorite stock among those pursuing a growth mandate.
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