This article originally appeared on Traders Reserve.
Now, we all know a stock can spike higher after a much better-than-expected earnings report. Conversely, a stock can plunge after a company reports lower-than-anticipated earnings results. And while these kinds of swings do happen fairly often, the more common occurrence is for a stock to run up (or to begin selling off) leading up to the earnings report. This is the classic case of buying the rumor and selling the news (and of course, the flipside to this coin is to sell the rumor).
Why does this happen? Well, it happens because traders assess the “rumors,” and then place their bets in anticipation of those rumors coming true. These rumors don’t have to be rumors in the traditional sense; rather, they can be based on such metrics as monthly retail sales figures, or the beginning of a new revenue stream from a new product, or any number of positives (and negatives) that occur in a company during the quarter in question. Traders know this, and then begin to buy up the stock in anticipation of positive earnings (or short the stock in anticipation of a poor quarterly report).
Once the money has been made, and the rumors have been confirmed, it’s time for traders to start taking their chips off the table. I call this trading strategy “buy the rumor, sell the earnings news.”
As traders, it’s our job to make sure we capture gains when we have them. If we begin buying a stock in anticipation of a good earning report, and the stock runs up significantly due to the increased buying interest, it’s only prudent to sell the stock and realize those gains once the catalyst for the buying is gone.
Once you’ve seen a solid bump in a stock you bought in anticipation of good earnings (or shorted in anticipation of bad results), it’s time to step up to the betting window and collect your prize money. You don’t want to let your trading capital ride, as holding it any longer exposes you to myriad risks that could cause the stock to turn south. The company could run into problems, or conditions in the sector and/or general market could change before the next earnings report.
Keep in mind here that we are talking about trading, and not investing. If you plan to hold a stock for the long term, then you shouldn’t buy the rumor and sell the news during earnings. However, if your objective is to make trading profits, then step up to the window and buy the rumor — then sell the earnings news.
For more trades, ideas and strategies, visit Traders Reserve.
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