Earnings Misses Result in Technical Damage

Jul 21, 2007: 6:39 AM CST

The Big News of the day was of course the missing earnings consensus estimates by Dow giant Caterpillar (CAT) and Nasdaq/S&P 500 giant Google (GOOG). These major point moves serve as a warning for those who like to speculate directly before earnings reports are released – doing so is pure speculation and lacks objective edge in trading.

Many traders – especially swing traders – prefer to be ‘flat’ or out of a position in a stock that will be releasing earnings soon – I hold this rule very seriously and live by it. I am happy to give up potential upside for the risk of potential avalanches in price movements from time to time.

There is always a large debate about whether to be “in” or “out” before earnings, and it depends on your perspective and trading goals – regardless, you must address this point (unless you are a pure day trader). Whatever you decide, do it consistently, and don’t try to outguess the market.

Here are the charts of Caterpillar and Google – note the “techincal damage” on the daily charts and the similarities in price action:

cat-july-20.png

goog-july-20.png

Both stocks gapped down through their rising 20 period moving averages, but ironically both stocks opened just at their 50 period moving average. Both stocks dipped just below that key zone before ‘ratcheting’ higher.

These stocks were great candidates for a “fade the gap” strategy (though both gaps were filled partially). As I mentioned last night, I figured after hours traders greatly overreacted with their ‘punishment’ of Google shares and expected price to rally upwards from the open. Both stocks exhibited this similar pattern.

From a technical standpoint, Caterpillar looks better technically, as the gap was further closed from a percentage standpoint. In addition, CAT closed solidly above its 20 period moving average, further confirming the bullish uptrend in the stock.

Use these examples as educational material for earnings plays – as to what can happen when earnings are missed, even slightly.

Also, for six reasons the general market has “fought off” bearish situations (such as the sub-prime housing crisis), visit the Fresh Trader’s post on “The Bull Market Fights to Stay Alive”. Great observations there.

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