Trading During Reporting Season: Expect the Unexpected

Twice a year in August and February, the good, the bad and the ugly of the past six months are poured over. Companies can bask in the glory of their profits and present their thoughts on the future, or explain away the failure to meet promised targets and hope to do better next time. Starting on the 1st August and 1st February, ASX-listed companies announce their results - a time that leads to many late nights for all analysts and researchers.

However, there is an important proviso to reporting season. If a company is already aware that their results will differ from analysts estimates by 10% then they will issue an announcement to the market,. These profit warnings or upgrades can come out of the blue and hurt the trader. For example, with a very strong Australian Dollar we may well see pre-reporting season announcements from companies that rely on overseas income. Additionally a company may decide to bring forward there results to win some competitive advantage over a rival.

Technical analysts who study the charts over many reporting seasons see something quite startling: the chances of an individual stock selection moving in line with the short-term technical indicators is at best, uncertain. The fact is that the risk-reward scenario of holding a CFD or Exchange Traded Option (ETO's).

Unexpected Results can Hurt High-leverage Products:

From experience, more short-term CFD and Exchange Traded Options (ETO's) traders get hurt during earnings season than at any other time of the year.

Why?

There are several mechanics at work during an earnings release.

• Firstly there are the raw numbers themselves - Did they actually beat the estimates? Sometimes it appears as they have, but how did the number crunches do it? If they did it on falling revenues, then they accomplished the feat by cost cutting or playing the currency spreads. None of them are indicative of great growth.
• Then we have the issue of just how much did they beat the estimates by? Quite often beating the estimates can be more a matter of creative accounting than a real estimate of business growth.
• Analysts' Expectations - Short-term technical analysis generally supports the jawboning of the analysts and their estimates. The CFDs or Exchange Traded Options (ETO's) trader sees the stock price moving with the expectations of the analysts, encouraging the trader to enter the trade. The next morning the company announces their earnings and “whack” the share price gaps down or falls quickly, despite the fact that they beat the numbers.
• "Guidance" - There is the all-important “guidance” from the CEO. The earnings released is already old news as they represent the half-year that has already past. Fund managers and analysts are very interested in what the company is doing now and what they think they will do in the future. If the CEO's guidance is less than encouraging, the stock may well take a knock.

Past Experience: We can take a look back to February 2007 to see some practical examples of the effect of reporting season.

The aqua circle is the day before the company reported. The green rectangle shows the MACD. As you can see in the above chart that the share price gapped up considerably the day BHP reported.

Please note, unlike its counterpart, RIO, or the Resmed chart below, there was heavy "fundamental" and "technical" support for a positive BHP report, along with the share price being supported in a strong short-term uptrend. Many dedicated BHP analysts were also upbeat about BHP. As it was BHP, stunned the market with is buy back plan.

Practical Example 2

As you can see with Resmed (RMD) above, the share price fell drastically after reporting. Obviously the market reacted badly to the release. Again, as in the earlier BHP chart, the yellow circle indicates the day prior to the release of the report and the aqua circle is the report day.

From a technical analysis perspective, note the volatility prior to the release of the report, suggesting uncertainty in the market place. The RSI was displaying bearish divergence prior to the release of the report (yellow rectangle). The MACD (green triangle) was tumbling along showing no strong or "obvious" signs of future possible direction of the share price. Upon release of the report, the RSI and MACD followed the share price movement down. and the yellow rectangle shows the RSI. Technically there was very obvious positive momentum shown.