Earnings season is a special time, when confessions and surprises are made. For those willing to be patient and wait for trade setups in the aftermath of earnings announcements, the spoils can be quite good and the probability of making gains rather than losses on a short-term time frame are reasonably high.
The two most common bullish trade setups tend to both be breakouts and retraces that can be bought. The only difference is how the retrace sets up. Two quick examples this earnings season are Wells Fargo
(NYSE:WFC) and Morgan Stanley
Morgan Stanley is an example of a positive earnings reaction that pushes to new highs and leaves a high-volume high that does not get tested. That's a good thing because the odds favor a retest of that high before too many bars pass. The other significant feature is that price does retreat to the breakout area to do a retest and regenerate sequence.
Although this particular case still has decent probabilities it is not the highest probability post-earnings trade. Nevertheless, it is worth pursuing if you can construct a reward-to-risk equation that is favorable. In particular, in this case an initial buy near the bottom of the final retest and regenerate zone and stops just below that provide minimal risk with the reward a test of the highs at a minimum.
The higher probability trade is exemplified by Wells Fargo because on the day of earnings, the bears jumped all over it early and got their heads handed to them as it reversed and has spiked higher ever since.
Although this break higher didn't break a swing point high, and thus no trend transition, the earnings-day bar and day-after bar have huge volume and now should witness good buyer support in that price zone. It almost got there yesterday. Note that if price does get through that anchored support zone, it will likely be due to extraneous factors causing general market weakness, and thus the lower zone is also ideal in that case for further purchases. Yesterday's market weakness did bring it back near the top of that zone, and volume did not expand as a result of the price pressure.
One last factor that is probably quite obvious is that the sector and the general market qualified trends should support the bullish trend of the stock. In the case of both of the above stocks, the major market sector is the financial sector, and a quick look at the qualified trends in the Trading Cube
do show sector and general market support for the continuation move. Do note that the financial sector is set to attempt to regenerate higher today on a retest-and-regeneration setup, and that will be key to the success of most financial trades, including the ones outlined here.
Here are a couple other stocks that set up yesterday and may provide entry today as a post-earnings trade.
SunTrust Banks Inc
(NYSE:STI) is a regional financial concern that also had a spike off earnings and now is drifting back in. This one doesn't have a high-volume high and thus may only offer a trade back to the $40 area on the first bounce, but again, it has a very high probability of doing so given its current trend, high-volume earnings spike, and the fact that this is the first retrace and it is retracing on lighter volume.
Webster Financial Corporation
(NYSE:WBS) has a similar pattern as to SunTrust Banks: a spike higher on earnings with a bit more push, then a fade. The first retrace into the base of the breakout bar when formed in this manner is the ideal buy area and in this case, that is the retest-and-regenerate zone.
Although this market continues to struggle to the upside, by my estimates, it likely has another week or so to stage a topside breakout or the probabilities of a larger retrace begin to increase. You can only sit still for so long while maintaining a higher-than-average bull posture. Market direction is necessarily a function of market tests, and once a sufficient number of tests fail to produce higher highs, then one has to recognize that the possibility of going the other way begins to rise. We are not quite to that point, but a break topside is needed soon or the risk will have risen to a level that one has to pull in their horns a bit.
Editor's note: L.A. Little is a professional trader, author, and money manager who has written several books and contributed material to many financial sites in addition to authoring his own: Technical Analysis Today. He brings a unique perspective to technical analysis, incorporating his extensive engineering and modeling skills when analyzing the markets.
No positions in stocks mentioned.