Trend trading during ASX earnings season: Tips to tame the traps

Many of you who follow my regular updates know that I am a trend follower. This means my investing methodology is to identify and buy stocks that show sufficiently rising price momentum. I may also look to short sell stocks that show sufficiently falling price momentum.

My trend following approach is one hundred percent technical. This means I place absolutely zero value on a stock’s fundamentals.

I accept that by not knowing anything about a company’s fundamentals, changes to those fundamentals may occur at any time to alter the demand and supply of the company’s stock – which in turn may trigger a change in the direction of its stock price. When this occurs, it’s very likely I will experience a loss on my investment.

It’s a trade-off between having a much simpler methodology compared to performing the arduous and difficult task of accurately assessing a stock’s fundamentals. As a trend follower, I accept I may enter a trade immediately prior to a trend change, and therefore experience a loss.

Which brings us to ASX earnings season, the twice-yearly minefield of news events that creates both opportunity and risk for all investors – technical or otherwise. Given news can be the worst enemy of trend followers, in this article I hope to provide each of you avid chartists with some useful tips on how to survive earnings season!

Earnings season = News!

There’s two months on the ASX calendar where investors receive a deluge of news. For most ASX listed companies first half reporting season occurs in February (after the December 31 half close), and full year reporting season occurs in August (after the June 30 half close).

We’re about to embark on the August one, with several companies scheduled to report their full year results next week. Kerry has an excellent earnings season calendar for you to use to keep track of all the key reporting dates for all the key ASX stocks.

For me, earnings season equals news.

Trend following is a rather mundane investing methodology in the absence of news (i.e., new information not previously available to the market). Trends tend to perpetuate in the absence of news that changes the prevailing mindset among investors regarding a stock’s earnings.

If news breaks that changes earnings expectations for a stock, it will very likely impact the stock’s demand-supply environment, and therefore drive its stock price to appreciate (positive earnings impact) or depreciate (negative earnings impact).

Good news vs bad news

News that drives the price in the opposite direction to the prevailing trend is the most dangerous to trend traders. The heading “Good news vs bad news” is me poking fun a little. This is because the concept of good news versus bad news depends on an investor’s positioning. Investors who are long or short will perceive a news event and subsequent price change very differently!

So, for me “bad” news is news that triggers a depreciation if I am long a stock, and an appreciation if I am short it. For simplicity, let’s call this “adverse news” – it’s news that’s adverse to our investment position.

Trend following post-earnings

A stock will usually be rewarded for beating expectations for the period just gone, and the share price will usually adjust to reflect the magnitude of the beat. Far more important for shaping the longer-term impact on a stock’s price, however, is its earnings outlook.

This is because the market is always looking forward, pricing stocks for their future earnings potential and not for their past earnings successes or failures.

A positive period result accompanied by a positive outlook can be stock price dynamite during earnings season. Just as explosive is the opposite combination – a negative period result accompanied by a negative outlook. It’s common to see prices jump or slump by greater than 10% in the trading session of an earnings release.

Rather than try and interpret the news and its impact, I prefer to heed the information embedded in the price response. So, if a stock rises sharply – I interpret this as a good sign investors loved the result and the demand-supply environment has swung to strong excess demand. I want to follow this move, that is – I like to buy after big post-earnings gains.

In the same way, a sharp drop in a stock’s price usually indicates investors are factoring poor future performance and the demand-supply environment has swung to strong excess supply. I want to follow this move, that is – I am compelled to exit (if I was long), and/or look to go short after big post-earnings losses.

Life360 earnings season case study: The first response to earnings is often not the complete response. It may take weeks or months for the news encapsulated in the company's results to be fully reflected its stock price.

In my experience, the first response to an earnings surprise is rarely the complete move. Not all investors are able to implement their changed views and resultant portfolio adjustments at once. It may take days, weeks, or even months for their intentions to be fulfilled based on prevailing liquidity. Ladies and gentlemen – this is what causes trends to form in the first place!

Managing trend following risks during earnings season

That’s what I like to do post results – it’s pretty simple – I go with the flow. I am a trend follower, no surprise there – going with the flow is my mantra!

But what about before earnings? We’ve discussed how massive post-earnings moves can be, what if one is following a trend and the stock delivers adverse news? Is there anything that can be done to prevent a big earnings day loss?

This gets to the heart of the biggest challenge faced by trend followers during earnings season: To trust the trend before an earnings release or not?

In my experience, news tends to break in the direction of the prevailing trend. I believe that stocks in uptrends are rising because of positive views of their earnings among demand and supply. When earnings season comes around, they tend to deliver good news for the period just gone, and they tend to provide a positive outlook for the next period.

Domino's Pizza (DMP) earnings season case study: More often than not, earnings tend to confirm the prevailing trend. In DMP's case, the prevailing downtrend was likely in effect due to the company's deteriorating fundamentals.

Similarly, stocks in downtrends are falling because of negative views of their earnings. These stocks tend to deliver bad news for the period just gone, and they tend to provide a negative outlook for the next period.

I could show you 100 examples of trends in uptrends breaking higher and 100 examples of trends in downtrends breaking lower to try and prove my point – but I won’t bore you with the details. What matters for this discussion is what happens when they don’t break in the direction of the trend!?

How does a trend follower protect themselves during earnings season? I have two important points here, based on before and after the fact.

Before the fact

First, before the fact, i.e., pre-earnings. I agree, earnings season can be a very nervous time for trend traders. Remember, I like the low volatility “the other 10 months of the year” the best. So there’s no harm sitting out earnings season altogether – or at the very least – holding back on buying / shorting a stock you’re interested in until after its earnings.

As mentioned in the last section, it’s post-earnings when you’re going to get a great look at whether the market loved or hated a result. Sure, you may miss a chunk of the move, but at least you can enter with greater confidence a trend now has the requisite catalyst to continue.

Investing is always a trade off between entering early with lower confidence, and potentially greater risk and greater reward, or entering later with lesser confidence, and potentially lesser risk and lesser reward. There are no free lunches!

Another option pre-earnings is to hedge your bets. You could sell half of your position (or some other portion) and look to re-enter post earnings if the trend remains intact. Again, risks are reduced, but so are the rewards if the stock reports great earnings in line with the prevailing trend.

After the fact

As for after the fact, i.e., after the damage is done, it’s a matter of doing the work a trend follower must always do. This means checking if your original thesis – i.e., the set of criteria that got you into the position – is still intact. For me this means trends, price action, and candles.

If collectively they continue to justify remaining invested after a post-earnings move, then I continue to do so. But, if they suggest the balance of demand and supply have changed to indicate anything other than excess demand (for prevailing uptrends) or excess supply (for prevailing downtrends), I must exit.

If this means I have to take a loss, then so be it. I take it. I accept it. I move on to the next great trend. Rinse. Repeat. This is what good trend following is all about, there’s always another great trend out there somewhere – your job is to go and find it!

Case Study: Wisetech Global

Earnings season equals news, equals volatility. In this Wisetech (WTC) earnings season case study, not two breaks in line with, and one against the trend.

Wisetech (ASX: WTC) is a fantastic case study in earnings season volatility. The last three earnings reports triggered greater than 10% price change post-results. Two times, in H1 FY23 and H1 FY24 delivered positive results in line with the prevailing long term uptrend. H2 FY23 results, however, delivered a massive 19.6% loss. 

In each case, the price tended to continue in the direction of the immediate price response post-earnings. This backs my contention that it’s best to take your medicine if the price breaks against your trade (e.g. in August 2023), and to hold or buy/add if the price breaks in line with your trade (i.e., in February 2023 and 2024).

Which way will WTC break when it reports its full year results on 21 August 2024?

Navigating the minefield

Whilst I contend news tends to break in the direction of the prevailing trend, I admit there’s always a sneaking suspicion in the back of my mind that the wonderful trend I’m riding has factored in too much in the upcoming results, and is therefore ripe for an earnings shocker!

This is why I have written this guide. As a trend follower, earnings season represents a turbo-charged risk versus reward equation unlike that experienced in the rest of the trading year. 

So, instead of going on holiday in February and August (although this is another option I!) I hope I’ve provided you with some practical strategies on how to survive and thrive this earnings season and the next. Bring it on! ✊

Earnings Season Calendar

To help you prepare for the upcoming earnings season, we've created a fantastic resource to help you navigate the ups and downs of company results – our Earnings Season Calendar.

It contains the reporting dates for all of the major ASX companies, as well as a downloadable PDF that contains consensus earnings estimates so you can see if your company met, missed, or exceeded market expectations.

It's a fantastic resource we're sure will become a vital part of your earnings season preparation. Enjoy!