Earnings Season: Approach with Caution

10/20/2015 6:00 am EST

Focus: STRATEGIES

Bob Lang

Founder and Chief Analyst, Explosive Options

"Generally speaking, we don’t want to rely on feelings for our trading strategy. It’s important to take a more pragmatic, technical, and unbiased approach," says Bob Lang, of ExplosiveOptions.net, who highlights how he plans to trade a bit tighter than usual during earnings season.

The stock market’s strong comeback from the lows we reached just two weeks ago is the stuff legends are made of...and this legend is repeating itself.

Just one year ago, we saw a similar rally occur on very powerful price action when the S&P 500 (SPX) moved nearly 200 handles up the chart. The 2014 action followed on the heels of the Ebola crisis threat. Markets endured a steep drop of 9.4% from all time highs thanks to an unknown outcome. That uncertainty led everyone to either pause or panic, but the fear subsided quickly and that big rally caught many out of position (most notably, the bears, who hung on too long and were once again routed after having their day in the sun).

Fast forward to this year. Yes, the recent move upward is stunning and persistent, but it comes on the verge of big earnings releases. Earnings estimates are down and the bar has been lowered substantially. Many companies may handily beat estimates.

Have stocks moved ahead of earnings? It’s quite possible, and now that we have a very overbought market, we could be looking at some pullback...even if numbers are exceeded. On the other hand, the good feelings generated by this two week-old rally may continue if earnings are strong.

How to Trade During Earnings Season

Generally speaking, we don’t want to rely on feelings for our trading strategy. It’s important to take a more pragmatic, technical, and unbiased approach. The charts are extended, but that doesn’t mean we cannot continue higher; overbought can stay overbought for far longer than you can imagine. When the euphoria dies down and the indicators start to turn south, you can expect a market pullback. Trying to guess when that will happen is foolish, though. The trend will change at some point, so be patient, listen, and pace your next move.

Playing names during any earnings season is always a bit tricky, but with elevated implied volatility this time around, we should be able to get a good read on the names that are worthy of a play before and after earnings announcements.

I’ll be playing earnings season a bit tighter than usual. My strategy will involve looking for price action and technical signals, particularly volatility (strangles/straddles) for plays now and post-release. I’ll also keep an eagle eye on flow, stock volume, and chart patterns.

By Bob Lang of ExplosiveOptions.net

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