Thursday, September 13, 2007

Earnings Season: To Hold Or Not To Hold, That Is The Question

Holding a stock (day or swing) trade into earnings can very often lead to some fairly large profits. However, it can also lead to some very large disastersso large that it just may be the last trade you ever make.

When I was still an active day trader and now as moderator of Daytraders.com, I have witnessed both sides of this phenomenon from each perspective. I have lost big and was lucky enough to catch a few winners. Yet, after years of experience, observation and unscientific analysis of this practice, it is my opinion that I was just thatlucky.

First of all, holding overnight or even a few hours during the day waiting for an earnings report has removed you from a pure day trader status to a swing trader. There are merits of both methods of trading, which is fodder for a future article. Moreover, I will mention, that as common sense would suggest, that the longer you hold a stock as a trader, the more apt it is to move against you.

Most people, including most analysts, dont really knows what is going to happen until the company releases their earnings. Sure, there are a lot of folks that will profess to be a genius at predicting such things, but I havent seen it. In fact, I have yet to see anyone really much more accurate, if any, than that famous sitcom parrot that used to pick stocks using the Wall Street Journal lining the bottom of his birdcage. Yes, I said parrot, as in, Polly wants a cracker!

When someone asks me if they should buy such and such stock because they are about to release earnings, I always tell them the same thing, As a trader, holding onto earnings may be the single most dangerous thing you can do. I suggest that if you are not willing to hold that stock for the next three to four months and into the next earnings period, then you should avoid the trade. If you hold into earnings and it misses their numbers, you may forced to hold the stock until the next reporting period or selling it a big lost. Or it could mean holding into, yet, another earrings report, and the beat goes on. If that be the case, you are not trading now. You are an investor, and as an investor you should have done your due diligence on the stock or not invested!

Too many traders focus strictly on the numbers, rather than what the company made or lost and how their actual numbers compared to analyst and company estimates. However, very often these numbers will have little of no bearing on how the stock will react to other information that is released at the same time. Guidance, where the company sees the future, may be the bigger item to be considered. Beyond that there is often bomb shell news in the reports that is all too often overlooked in the first few minutes or even hours or days after the release. These might be items like investigations by the SEC or some other law enforcement agency. They could be announcements of lost contracts, lawsuits, patent disputes and on and on. Any number of negative factors can far outweigh how the stock will trade as this information is dissimulated and digested by the street.

Adding to the additional risk of trading stocks on earnings is the somewhat questionable practice of some companies. They try to soften the reaction to what they know will be seen as earnings by releasing good news a few days or even a few minutes before releasing the bad.

I have seen companies release news of a huge contract win the day before they report earnings, and I watched the stock move up a considerable percentage. They know darn well that the next day they will be releasing a poor earnings report that will send the stock much lower. These positions can fall 8-10%, and in some cases I have seen stocks lose 25-30% of their value.

Traders that find themselves holding these shares will take a huge loss in their trading accounts, and all too often it will put them out of the trading game.

If you feel you just have to take the chance and try for the big gain on earnings, I suggest you dont hold a very large position. Maybe or the number of share you would normally buy. If the stock moves against you, you can cut your loses with minimal damage or buy in at the bottom and try to average out.

I also suggest you only do this if you have some extra money lying around, money you dont mind losing. And if you do have some extra money you dont mind losing, can you please send some of it my way? I have been around a long time, and I have yet to see any of that money. I have seen a lot of just plain ordinary money, but Ive never seen any money that was extra enough for higher risk behavior like holding into earnings.

My final piece of advice is: Dont Do It!!!

Happy trading!

No permission is needed to reproduce an unedited copy of this article as long as the About The Author tag is left in tact and hot links included. Send all comments and questions to: floyd@TraderAide.com.

Floyd Snyder has been trading and investing in the stock market for three decades. He was on the forefront of the day trading craze that swept the nation back in the late 1990's, both as a trader and as the moderator of one of the Internet's largest real time trading rooms, http://Daytraders.com He is the owner of http://www.TraderAide.com and Strictly Business Magazine at http://www.sbmag.org