As the first-quarter earnings season comes to a close, some reflection on best practices can start you on the right path for the next season.
Earnings announcements, or other known events, increase the risk of trades going against you, and that risk needs to be mitigated as much as possible. Keeping losses small is a key tenet of swing trading and an earnings report gone wrong can slam your portfolio — and your confidence.
As a result, you have to get used to selling early. Sure, the stock may go up without you, but the goal of the swing trade is to capture the bulk of the gain as quickly as possible and move on to the next trade. Fewer days in the position means fewer chances for things to go against you.
Selling early can also help you avoid periods of flat performance. This is also important ahead of earnings as things may quiet down in the days leading up to a report. Investors may take a wait-and-see attitude, which means you have your capital at risk for less potential reward. Locking in the gain early takes your capital off the table and reduces risk.
Take Alibaba (BABA). It was added to IBD's SwingTrader on April 10 as it broke out of a short consolidation in the highest volume in 20 days (1). It was initially slow to start, but an improved market on April 24 made the prospects look better for the stock (2).
Alibaba hit its first profit goal of 5% on May 1 and profits were taken on the full position (3). Considered in the decision was how long the position was open in order to get the 5%. The stock was getting extended in its fifth consecutive week up, it was nearing potential resistance at 120 from an old high, and the recent highs were being made on a paucity of volume.
The next profit goal of 10% seemed less likely to be achieved before earnings in the next couple weeks and a pullback or pause was expected. In hindsight, the stock did go up more before earnings but the reality is the choice proved to be a good one. A small pullback did ensue and the stock would most likely have been sold as it spent a couple days below its 5-day moving average line (4). The early sell got a better price.
When earnings were announced for Alibaba, it had a day of extreme price discovery (5) in what could have easily taken significant profits away from the position. It's a good example of the risk that can easily be avoided. Selling early might not have gotten the highest price but it was certainly much safer and the stock can always be bought back after the risk subsides.
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