If you're a trader, there's always the dreaded “earnings season” – when deciding whether to hold onto your position during that time can be tricky. Luckily, TraderLion has some rules of thumb for navigating through it and deciding when to hold through earnings or sell.
The golden rule
Here is the big golden rule that we use. You must never hold a stock through earnings if you don’t have enough cushion to protect against the potential downside. This is a key part of our risk management strategy and we’ve seen it work over the years. We always make sure that we have enough cushion in place to protect ourselves from any losses associated with earnings reports.
What is a cushion and how do we measure it?
The cushion is referring to your progress in the position. If you are up 20% we would call that a 20% cushion.
The cushion provides a buffer in case of unexpected losses. If the stock gaps and moves against you, having a cushion will help provide stability and minimize potential losses. Knowing how much cushion you have is essential for making a smart decision about whether to hold through earnings or not.
Questions to ask yourself
- Is the stock you own liquid on the options market?
- If the above is true, head over to optionslam.com, type the symbol into the search on the top right, and look at the Implied Monthly Move or Weekly Move into earnings.
- If the stock you own is illiquid on the options markets – is the cushion you have into earnings a minimum of 10%?
- How has the earnings season been thus far – have stocks in the same industry group reacted well to earnings in general? Is the market in a solid uptrend with healthy, broad-based leadership?
Answering the above will give you a solid answer on if you should be holding into earnings and if you have a sufficient cushion. Remember that earnings events are binary events – you must be willing to give up the gains you may have on the stock and there are no guarantees.
Let’s say the Implied Move is 15%. This means the stock is expected to move up or down 15%. You have a 50% cushion which means you have room in case they gap down. Remember we are dealing with the stock market here and it can always gap up or down further but the Implied Move is a good guide overall.
Now it’s up to you if you want to hold or sell and be ready to buy it back. This is when you would ask yourself question #4. Let’s say stocks in the same group have been having good earnings and the overall market is in a healthy uptrend. This would be further evidence to support holding through earnings.
If the market is healthy and in an uptrend, other stocks in the same industry group look good, and we have enough cushion, TL will generally hold. Of course, this will all come down to your own personality and trading style but if you are looking to capture the big moves of the strongest stocks in the market then holding through earnings is part of the process.
Try our free position size calculator to help determine how many shares to buy.