Their Story. Trading in the earnings season

Every quarter, as public companies present their earnings report-card to investors, traders too gear up to make the most of the volatility that inevitably occurs in this period.

If you watch stock markets closely, you might observe that stock prices tend to open with large upward or downward gaps on many days. While these gaps can be due to various reasons, earnings announcements are one of the factors that result in the formation of these gaps. As companies get into an over-drive in their effort to woo investors, price action gets extremely volatile in such periods.

Information overload A key reason for heightened action around results announcements is that companies make many important disclosures about their operations at this time. The quarterly report is accompanied by a press conference and analyst conference; key performance metrics are also put up as presentations on the website. It is, therefore, not surprising that investors and traders find plenty of new information regarding a company in these releases and meetings and as a result their view of the company can alter.

Information technology companies also announce future guidance for the next quarter or year along with the earnings reports — adding to the volatility. The results of large IT companies, such as Infosys, Wipro, HCL Technology and TCS are, therefore, eagerly awaited by the trading community, with many taking positions prior to the event.

\ Need for discipline

At times, excessive volatility can make trading difficult. It is perhaps for this reason that some prefer to stay away from trading on earnings announcements. Devyani Jain, a Business Analyst at Akamai Technologies, and an active trader/investor since the 2008 market crash, says, “Although the volatility that gets created around the results season can be perceived as an opportunity to make a quick buck, one should always exercise caution and not get overzealous and over-indulge. After all, there is no such thing as a free lunch.”

Another factor that affects stock movement following the earnings report is ‘investor expectations’ or ‘street expectations.’ For instance, if the company’s performance is gloomy, the stock price could experience selling interest and witness a sharp fall. But if investor expectation is met, then the stock price could skyrocket. These earnings surprises create volatility, which creates an opportunity for trading or investing.

Bhubaneswar-based Tarang Meher, a full-time trader, mainly trades in options and trades online with the discount broker Zerodha. He uses the short-strangle strategy to capitalise on the trend. During results announcements Devyani also prefers trading in the futures & options segment, which allows her to take advantage of large price moves. But, S Dheepak, a full-time investor, has a divergent view and he prefers to stay away from stocks announcing their results.

The check-list Here are some key factors/guidelines to keep in mind during the earnings season that can help you survive and succeed. One, market’s reaction is hard to predict. A stock can rally on poor earnings and can slump on good earnings. But that said, do remember, the market is always right.

Companies can announce earnings before the market opens, during trading hours or after market close. The results reported before or after the market will regularly result in pre-market or post-market trading and the stock can move sharply up or down, resulting in gaps. So the timing of the announcement plays a big role.

“If a company’s results are released post-market-hours, the increased flow of information can cause the stock to open with a gap up/gap down over which a trader has no control. So it’s best to trade such stocks whose results are going to get published during market hours,” says Devyani.

Barnali Deb Kanungoe, Manager-Content Partnership at ParentCircle, says she waits until the second half of the day to let the market stabilise. She also believes that all aspects of the results need to be carefully scrutinised for anything hidden between the lines. Another important guideline is to closely watch the market’s reaction to the results. Larger participants such as foreign portfolio investors or mutual funds can analyse the impact of the results well before retail participants and steer the stock movement.

What they trade Tarang has already traded, in this results session, in the stocks of Infosys, TCS and HDFC. He is looking forward to trade in SBI, JSW Steel and some others. Devyani has a slight inclination towards automobile stocks.

With the results of Eicher Motors, Hero MotoCorp and Bajaj Auto slated to come over the course of the next few days, she plans to make the best use of the opportunity and make some handsome returns.

When one trades on specific sectors, it is best to remember that companies post better numbers in some quarters. For instance, retail sector posts good numbers in the quarter ending December due to festive offers that boost sales and profits. Voltas’ results are bound to be good during the summer quarter and Assam Tea’s results will perk up during the winter quarter, says Dheepak, who follows a combination of both technical and fundamental analysis. Tarang also adopts a similar style; he selects a stock based on fundamentals and times entry and exit purely on the basis of technicals.

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