Trading during reporting season

With the end of the financial year a recent memory we can look forward to the reporting season that will be upon us soon, starting on the 1st August ASX listed companies will announce their results, a time that will lead to many late nights for all analysts and researchers. Twice a year, in August and February, the good, the bad and the ugly of the past six months are pored 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.

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 compamny may decide to bring forward there results to win some competitive advantage over a rival, as Woolworths has announced they will do this year by releasig their results a week early.

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).

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’d they 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.

Moreover, the short-term technical analysis generally supports the jawboning of the analyst’s 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.

Secondly, there is the all-important “guidance”. 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 guidance is less than encouraging, the stock may well take a knock.

We can take a look back to February to see some practical examples of the effect of reporting season. We had BHP in the pending "Trade Suggestions" area from the 1st February, the date of analysis, before it triggered in on the 6th February, the day before reporting.

The aqua circle is the day we entered the trade on the 6th February 2007 while the yellow circle is the day BHP 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 techincal analysis perspective, note the volatilty 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 pirce. 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