Today’s conversation is an oldie but a goodie. Earning season is back in play, so it’s a great time to review another timeless process you can use in trading.
Firstly, what do stock, ETF, and futures traders need to know about earnings? Earnings are a type of “hot zone.”
What is a hot zone?
Hot zones are certain events, such as earnings. They’re volatility and volume events that are scheduled and coming out on a particular day.
Many traders love the “no pain, no gain” or “no guts, no glory” of taking something into the volatility of the earnings hot zone. I get that it’s the same with the non-farm payroll hot zone, a central bank event, or Fed chairman speaking. Any of those hot zones will create high volume and high volatility. Earnings are just one of them.
Let’s get to how to trade this hot zone…
Start scanning six weeks out from the earnings date. This is the “6” in the 6-4-2 routine of trading earnings. In front of this earnings hot zone event, I want to see that the market is already rallying.
Look at the daily time frame. That tells me market participants are already expecting a type of response. Usually, but only sometimes, the bulk of your profits will be made in an up-trending market.
This is the structure of the 34 EMA Wave (image above). When I have an up-trending market starting six weeks out, even into the four-week window, that’s the sweet spot. Six to four weeks out, even three to four weeks out, is okay. This is the “4” in the 6-4-2 routine.
Looking for a pullback to buy
We’re looking to buy the pullback and play the swing high within that six- to four-week time frame. We are looking to capitalize on the anticipation of a rally in earnings.
Start looking for these opportunities six weeks out. Look for the trends. Remember that the bulk of your profits isn’t going to be the earnings number but rather that ramp-up in anticipation.
You want to see the structure of anticipation in this uptrend environment. The goal is to not be in the market at earnings!
Within two weeks from the earnings report, I like to say “no” to any setups. I’m running out of time, probably ten trading days or less. The implied volatility is going higher. There’s not much I want to do in two weeks before the earnings date. Yes, you guessed it…
That is the “2” in the 6-4-2.
The closer we get until the earnings day (within two weeks), any trades get troublesome because you have less time. It will leave little time to see the follow-through we need and enough time to get flat by earnings. That’s why I like starting so far in advance.
Be aware that the implied volatility increases within two weeks of earnings, and the market can start acting strangely. There is a pre-play strategy we’re talking about right now, playing and being flat before earnings.
Earnings aren’t just a stock or ETF phenomenon. It affects futures, too, because if you’re trading the indices, you’re selling a bundle of stocks.
Start with a 6-4-2 foundation.
You’ll realize, as futures traders, earnings do have an effect. Specific stocks and certain sectors are going to affect the indices.
As an ETF and index trader, earnings season is a “tail wags, the dog season.” In other words, if a stock (even a low-weighted stock) has a disproportionate price move, it can affect the more extensive index or ETF.
This is not only a stock strategy; it’s a strategy that will influence how you view volatility in trading ETFs and futures. Looking for an uptrend, buying on pullbacks, and following plays as the market’s attention is heightened due to the earnings release is the play. We are playing the rallies into earnings in the trending names.
