How To Trade Earnings Season

Over the next week or so, we will see quite a few significant energy companies' Q1 earnings reports, culminating in the big two, Exxon Mobil (XOM) and Chevron (CVX), who will report on Friday, April 27^th. Earnings season is in full swing and at that time each quarter, one of the questions that I am most frequently asked by retail investors is how best to handle it. Now seems like a good time to talk about just that.

When I tell people the answer to their questions about a strategy for earnings season, they are usually not happy. That is because, in most cases, the best strategy is to essentially ignore it. Don't react to the numbers. Let the dust settle, then reassess any positions you might have in the light of the new information gleaned. It is always tempting to try to react to news, but if you are a long-term investor whose holding period is measured in years rather than minutes or hours, you should be more concerned about trends, strategy, and the execution of that strategy than any one quarter's results. Even if you are a trader with a good setup, the chances of you reacting to an obvious beat or miss before institutional desk traders is basically zero. Trying to do that means that you are late to the party, and your trade just gives them an opportunity to close out their trades.

That said, though, there are some things in earnings reports that do have a bearing on the long-term outlook and that should be analyzed. Most notable among them is the forward guidance that they often contain, giving investors an idea of what to expect in the coming quarter, and usually for the full year ahead.

That guidance is always significant, but not necessarily because it is always right. The CEO and other senior management of a company are the best-placed people to assess what is coming, but even their estimates are really no more than guesses. They have a good handle on demand, of course, and know what resources their company has and how close they are to exploiting them, but they cannot predict the economy, natural disasters, or any other external influence, good or bad. The importance of their guesses to investors, however, comes from the fact that those guesses set the bar for other, more influential guesses… the analysts' estimates off which most stocks are priced.

That is where the opportunity comes for longer-term retail investors and swing traders. You cannot beat the pros to the initial trade, but you can take a measured position based on what will follow. That is why what I usually look for at earnings time is a retracement of an immediate, dramatic move caused by some profit-taking on short-term positions. That often comes, and when it does, it can be a good opportunity to enter or add to a long-term position.  The guidance will prompt a response itself, but there will usually be another, more sustained move in the same direction when the analysts update their estimates based on the new outlook.

So, the most important thing about trading through earnings season for retail investors, in energy or anything else for that matter, is to understand where you may have an advantage, or at least can compete on a level playing field. It is not in speed, nor will it ever be, but you can get ahead of somewhat predictable longer-term moves and trends if you look at the results that way and understand the likely reaction to forward guidance.

That is what I will be doing next Friday. I currently have no position in XOM or CVX, having sold out of both quite recently. Their results for Q1 won't dictate whether or not I get involved again, but the assessment of oil demand and forward guidance from their management teams probably will.