Why Do Stock Prices Fall After Good Earnings Announcements?
It’s happened to many novice stock traders. You’re on your way into work and you hear on the news that some well known company announced great earnings after hours the night before. You’ve been waiting for an opportunity so you decide to buy as soon as the market opens.
Despite the fact that the price is already up 10% or more at open, you make your purchase and sit back to watch the fun. Things go extremely well for the first half hour. The price rises a good 10% further and you congratulate yourself on your wise purchase.
Then, about 30 minutes into the trading day the stock does something remarkable. Its price rise turns and the price begins to drop. It drops quickly and within an hour loses all the gains for the day. It doesn’t stop there too. Aside from one or two buying flurries it continues it’s downward momentum and ends the day down 10% on opening price, leaving about a 10% gain on the closing price the night before.
Over the next few weeks the stock price continues to decline and by the time it slowly turns positive again a couple of months later it has lost 30% on the price you bought it for on earnings day. So what happened? What we are witnessing here is classic manipulation of market hype by the ‘smart money’ to take money off the ‘dumb money’.
The smart money are the 3% of traders and investors who make money trading the markets and the dumb money are the rest who lose money, usually to the smart money. You get the picture.
The answer to this is to look at what the smart money did. Emulate their strategy and you too could find yourself on the winners’ side for once. The answer is simple and obvious, all it needs is pointing out. If we search through a few well known company 12 month stock charts it won’t take long to identify one which has been doing this, ie. showing consecutive quarters of meeting or beating market expectations, then dropping in price before heading up again to their next earnings announcement three months later.
The smart money strategy should be clear. Buy ahead of the earnings announcements and sell to the buyers on the day of the announcement, preferably during the first 30 minutes of market opening, during the buying ‘frenzy’. That’s all they have to do.
As the smart money dumps their stock and the buyers start to dry up, the stock price falls, eventually over the next few weeks to what could be considered a ‘fair price’ of some 20% lower. This happens all the time and the dumb money falls for it over and over again.
In terms of time frames the best time to buy in would be about four to six weeks ahead of the earnings announcement. You need to get in as the price starts its steady climb upwards. This will happen between four and six weeks prior. Too early and you may find yourself getting stopped out at a loss. Too late and you may miss the early gains.
Getting in at the right time can however means gains of 25% or more leading up to the earnings announcement, and that’s before hype drives the price up after the announcement. Statistically the sweet spot has shown to be in the few days leading up to the one calendar month ahead of the earnings announcement.
Use the ‘Ten Steps’ buy in strategy shown in the website link at the end of this article to secure your position and mark in your diary to check the after hours announcement and be at the ready as the market opens the next day. Once you’re secured your position and your stops are at or above your buy price, follow the price of the stock upwards over the next few weeks. Keep your sell-stop well clear as there’ll likely be some turbulence on the way up.
Then use one of the following three exit strategies depending on the results announcements:
Company beats market expectations. If previous earnings patterns hold true (as it should) then expect the price to jump overnight and start the next day up. Let the initial buying frenzy drive the price up still further and then sell at market price between 15 and 30 minutes after opening. Total gains for this trade could be anywhere between 30% and 50%.
Company meets market expectations. This would mean less hype and less of a buying frenzy at market opening. Gauge market sentiment and be prepared to exit at market price at market opening. Total gains for this trade could be anywhere between 20% and 30%.
Company fails to meet expectations. If previous earnings patterns fail to hold true then exit at market price at market opening. Total gains for this trade from the weeks leading up to earnings announcement could be anywhere between 10% and 20%.
You can see that, aside from any large scale ‘force majeure’ which overshadows normal stock market movements, no matter which way it goes you will still profit from this stock trading strategy.