Holding Over Earnings? Know Why You Are Holding.
Regarding holding a stock over earnings — I believe that each trader/investor must determine WHY they are holding a stock.Using BAC as an example:
1. If you are holding the stock because you believe that the banking industry will continue to do well in 2010 (i.e., free money, steepening yield curve, recovering economy, etc), then you are holding the stock for fundamental reasons. The stock is a proxy for the company. In that case, it makes sense to hold it over earnings. And if that is indeed your view, then you really cannot lose by holding over earnings. If the stock reacts poorly, then it is on sale and you can add to your position. If the stock rallies on the earnings report, then you are being paid off for holding the stock. Again, you’ve got to have a bullish fundamental thesis for this approach.
2. If you’re holding the stock because you just think that it’s gonna go up (an equally valid, though different, thesis), you are really holding the stock with a focus on the behavior of traders (i.e., “technical” reasons) and not for any particular fundamental reason. In that case, I think you morph from trader to gambler by holding over earnings. Now, this is not necessarily bad, because sometimes a “gambler” has the odds in his favor and the speculation has a very favorable risk:reward profile.
Example: If a stock has rallied very strongly prior to earnings, then the odds favor selling before the earnings report is released because it is quite likely that strong earnings are factored into the stock price. The stock is likely to be sold irrespective of strong earnings according to that old Wall Street adage “Buy the rumor; Sell the news.”
A stock that has instead really sold off prior to earnings is reflecting strong selling by traders who anticipate lousy results. So the stock becomes depressed. Traders have factored poor earnings results into the stock prior to the release of those earnings. The result? The stock rallies in response to lousy earnings!
This strange phenomenon of rallying on lousy earnings and selling off on good earnings is what drives so many smart people crazy! They just don’t get it! I understand the difficulty of grasping this concept because it does not make sense. A company that is firing on all cylinders is worth more than a company that is wallowing in the mire.
But it does make sense if you focus on the behavior of traders before and after earnings. Only when you focus on the price action prior to earnings can you even begin to understand the price action subsequent to earnings.
Back to Bank of America: This is a difficult call because the stock is not really that far above it’s 50-day moving average.
It really hasn’t done that much in anticipation of earnings, though the price action is more bullish than bearish. As such, it’s a bit of a crap shoot. Therefore, I’d go back to the two alternative theses outlined above. Are you holding the stock for fundamental reasons, or for a quick pop? (In my case with JPM, it’s for a quick pop. I’m concerned that Meredity Whitney is right about Goldman Sachs, and I think other traders are too. As such, I’m wary of holding JPM over earnings, even though they announce before Goldman. If Meredith is correct about Goldman, then JP Morgan is likely to surprise to the upside. I think it’s a high risk trade).
Compare Bank of America’s chart with Banco Santander Chile (SAN).
SAN is very extended above its 50-day moving average (nearly 9% higher). That kind of extension is the by product of strong, aggressive buying. That buying pressure is finite. It’s unlikely that the stock will stay at such extended levels from the 50-day moving average because traders will back away from an obviously extended stock.
That leaves two scenarios.
First, SAN might trade sideways, thereby allowing the 50-day moving average to catch up to it.
Second, SAN might sell off and fall back to the 50-day moving average. Either way, it doesn’t make sense to buy SAN at this level, and my bet is that the stock will fall in response to earnings.
Hope this helps illuminate the “do I hold over earnings” conundrum.