Understanding Earnings & ETFs

So the thing that’s on my mind this week in the markets (and probably will be for the next three to four weeks) is earnings. Each week’s earnings are going to be focused on a few key stocks and the first real week of earnings keys off a major sector.

In this case it’s going to be financials: XLF.

When financials are being released every quarter, that’s generally speaking the beginning of the fresh earning season — it sets the tone.

So what should you be aware of when looking at financials?…

The Broader Market: 

You want to be aware of where financials are weighted in the specific broader markets. Think about the S&P futures and the SPY —  ETF alternative — as well as the YM/Dow futures along with the DIA ETF alternative. Those two specifically, are quite sensitive to financials. Now, a more minor index, the RTY futures and the IWM ETF alternative are also quite sensitive to financials.

Whereas, the KRE (or regional bank ETF) is going to be sensitive to what’s happening in the broader financial picture. So those three markets: the Dow, S&P, and Russell definitely are on my mind as a financial tip, because that’s where most of the impact is going to be.

That’s going from the earnings to the broader market. 

Now Let’s Go From The Earnings To The Individual Stocks…

This is where I’ll take a look at the calendar preferably no less than two weeks out, and I’ll be aware of which stocks are releasing earnings ideally starting four weeks out (sometimes even as far as six weeks). Definitely not the day of, Gang!

This helps to ensure I’m well aware of the potential impact. Now, speaking specifically to the impact… we’ve got heavily weighted stocks within a heavily weighted sector of the broader averages.

So there’s absolutely going to be attention grabbers and market movers. Individual stocks can move the broader average and the sectors during earnings season. Unlike any other time, it’s what I call “the tail wags the dog” season. Why the tail wags the dog? Because these are smaller individual names.

When you think about the sea of stocks in the financials (or the sea of stocks within the S&P, the Dow, and the Russell), when one stock has a major event that everyone’s ready for, and it’s capable of moving two times sometimes even more historically. What’s that create? Well sort of the perfect storm of an important stock coupled with higher volatility. That singular event alone, even for a slightly less weighted stock can make a multi percentage impact. 

Example — JP Morgan:

JP Morgan is the second heaviest weighted stock in the XLF, and it’s also weighted in the S&P. An inordinate amount of movement on earnings with JP Morgan can make a big, the “tail is wagging the dog” effect on the XLF ETF and the SPY (along with the NASDAQ).

So, during earnings, these are the kinds of moves and impacts that you should keep in mind.

Of course it presents opportunity, but if you don’t have the timing right, and if you don’t focus on the potential volatility impact, it’s also a very dangerous time for a lot of traders who just see the potential moves. Understanding how relative out performers impact the market AND how ETFs work are the keys to successfully trading these quarterly opportunities.

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