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Winning strategy for earnings season: trade at 52-week highs

July 24, 2023

The stock market has been on a strong upward trend, catching many investors by surprise. Now, as we approach earnings season, where companies report their financial performance, the stock prices of many companies are at their 52-week highs. This upcoming month of earnings reports will be crucial for these stocks, and investors are faced with a decision: take profits now or hold on to see how the companies perform.

What is earnings season?

Earnings season happens four times a year and is busiest during weeks four through seven of each quarter. During this time, companies listed on the stock exchanges report their business performance for the previous quarter. They reveal their revenue and earnings per share (EPS), which represents the company's profit for each outstanding share of common stock.

The companies often hold conference calls during this period to provide guidance for the upcoming quarter or fiscal year. This information helps analysts, traders, and investors understand what to expect in the coming months.

How does earnings season affect stock prices?

When the earnings numbers are announced, the stock market reacts quickly, with investors either buying or selling the stock based on whether the outlook is positive or negative. Surprising earnings figures can cause significant market shocks, leading to stock prices moving more than 10% in a single day.

Trading at 52-Week Highs

Despite the overall bull market, individual stocks may still have room for growth even if the market has reached new highs. Before earnings season, investors should consider two crucial questions:

  1. Have stock prices already factored in perfect expectations?
  2. Will the earnings meet the high expectations?

For the first question, the answer is often yes. When a stock has already experienced a substantial price increase before the earnings report, any negative surprise can lead to a sell-off.

Regarding the second question, it's uncertain until the earnings reports are released. However, some companies have already shown impressive performance, adjusting well to manage costs and dealing with inflationary challenges. This might lead to healthy bottom lines and better profit margins.

Trading Strategies for Earnings Season

To navigate earnings season successfully, investors can adopt a few different approaches:

Sell and Re-enter: After a significant run-up in a stock's price, it's prudent to take some profits off the table. If the company's stock price pulls back after earnings, investors can consider re-entering at a more favorable price.

Let It Ride: If a company reports an outstanding quarter, the stock price may continue to rise. However, investors should be aware that even with impressive numbers, stocks can still be sold off after an initial jump. In this case, a nimble mindset is essential for those who choose to hold on.

How to Trade Post Earnings

Whether trading before or after earnings, it's crucial to know which companies are reporting. After earnings are announced, there are two main scenarios to consider:

Buy the Dip: If a stock price drops significantly after earnings, it could present a good buying opportunity. Check the earnings per share and guidance to ensure there are no major negative signals. If the fundamentals look good, examine the stock's technical indicators, such as moving averages and trend lines, to identify potential support levels for buying.

Set Entry, Target, and Stop Loss: When entering a trade, patience is key. Choose a target price at which you'll sell to lock in profits. Additionally, set a stop-loss order to limit potential losses if the trade doesn't go as planned. Preserving capital is crucial for long-term success.

In Summary

The stock market is showing strength, with many stocks reaching 52-week highs. As we approach earnings season, investors face important decisions. Having a well-thought-out strategy is essential for navigating earnings reports, as there will be both disappointments and positive surprises. Staying nimble and prepared is vital during this period. One approach to consider is investing in growth stocks that demonstrate strength in their price performance, as this strategy has a higher probability of outperformance regardless of the overall market's movement.