It’s Officially Earnings Season, Here’s What You Should Be Cautious Of

by Darrin Donnelly on October 10, 2010

Earnings announcements can create chaos on Wall Street.

Earnings announcements can create chaos on Wall Street.

The market closed last week in typical “calm before the storm” fashion as the indexes trended sideways prior to some important earnings announcements set for the coming weeks. 

In particular, several leading Darvas stocks quietly finished the week flat or lower on decreasing volume.  This action tells us investors are waiting for more information before driving these leading stocks higher or lower.

As we approach the earnings season, a Darvas trader needs to be on his or her toes. 

You must know when the stocks you’re holding are set to announce their earnings and adjust your positions accordingly. 

An earnings announcement and subsequent conference call can produce wild swings in stocks, especially fast-moving Darvas stocks.  It’s not uncommon for a post-market earnings announcement to cause Darvas stocks to gap-up or gap-down 10-20%.  In some cases, stocks can swing 30% or more. 

While such swings can be great news on the upside, a downside surge can be devastating.

So what is a Darvas trader to do?  Should you sell your position prior to an earnings announcement?  

Selling an entire position may be a little extreme, but selling SOME of your position, depending on when you made your purchase and how much of your portfolio the position accounts for, is often a very good idea.

The best thing to do is asses the risk versus reward for each stock you hold. 

If you bought into a position that is now up 30% from where you bought it, you might conclude that the risk of a 15% drop is worth the potential reward of a 15% rise off of earnings. 

However, if you’re holding a position that is flat from your buy point, you might determine that a 15% drop is just too much risk for your portfolio to handle and therefore, you’d want to lighten up the position.

Remember, you don’t have to make all-or-nothing decisions.  Cutting back your position even 10 or 20% can often alleviate your risk to a satisfactory level. 

And here’s something that is often forgotten: you can always buy back into a position if the news is good and your stock gaps up a great deal. 

Extreme gap-ups can be a sign of higher prices to come.  While amateur traders are usually overly-cautious after a big gap-up, thinking that they already missed the big move, major gap-ups after positive earnings announcements are actually a great place to pyramid into an already-established position. 

Another thing to remember as we head into earnings season is that, often times, ANOTHER company’s announcement can have a big impact on your company’s stock price. 

For instance, Google is set to announce their earnings on Thursday.  While GOOG is definitely NOT a current Darvas stock, it’s possible that what they report and what they talk about on their conference call will have a major effect on several Darvas stocks. 

BIDU, Google’s search engine competitor in China, is an obvious example.  But what GOOG says could also have an impact on the price of a company like AAPL, as these two tech giants are competing ever-more fiercely in several different fields, or even NFLX, as Google tries to enter the movies-on-demand market. 

Because earnings news can have a major impact on your stocks (even if the news comes from another company), it’s a good idea to avoid initiating a major position prior to these announcements. 

You may want to add a little here, sell a little there, maybe even lightly ease into a new position; but initiating a major position right now, prior to an upcoming earnings announcement, is very risky.

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* Portions of this article appeared in the October 10, 2010 issue of Darvas Trader PRO.  You can try Darvas Trader PRO risk-free for 30 days by clicking here.

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