The earnings season is underway bringing forth opportunities and pitfalls. Opportunities and pitfalls are opposites sides of the same coin. Earnings season brings about a heightened state of extreme momentum and volatility that can overwhelm even the most seasoned traders. It’s not a matter of if you will succumb to a pitfall, it’s when and how you remedy the situation moving forward. The single greatest advantage of earnings season is the elevated number of ‘windows of opportunity’ that present themselves when one path fails. In order to capitalize, its crucial to mitigate and remedy the five common pitfalls.
1) Impulse Trading
This common pitfall occurs from proper lack of pre-market preparation which makes it easier to succumb to the fear of missing out (FOMO). This fosters reckless trading driven by emotions that cause traders to chase entries hoping to buy high and sell higher or short-sell low and buy-cover lower. Unfortunately, this is exactly the type of reaction that algorithms (algos) bet on as they sweep up liquidity and offer it back at a premium. The old poker adage that says “If you don’t know who the mark is at a table, it’s probably you.”
Remedy: Integrate a consistent pre-market morning ritual to thoroughly prepare for the trading day. Filter a watch list of tradeable gapper candidates and their sympathy stocks to trade laggard reactions. Adding Fibonacci price inflection points on your charts improves visibility enabling a trade plan to materialize purely on price action.
2) Short-Stacked Accounts
This is a poker term describing having a small bankroll. For traders, this equates to having too small of an account. Intraday trading requires a minimum of $25,000 capital to meet Pattern Day Trader (PDT) rules. However, that is the minimum amount and any slip in value under that amount flags the account as the rolling three-roundtrip per five-days rules apply. Violating this rule triggers a warning on the first offense and a 90-day suspension of trading afterward. Having an account under $30,000 is considered short-stacked as it limits the ability to play higher-priced stocks that provide better price action and often results in overleveraging cheaper stocks which are less forgiving when they turn. Most importantly, it hinders your ability to absorb wiggles which means more stops must be taken to re-cycle available capital. Worst case, a short-stacked account often causes traders to get “trapped” in a losing position as the account value drops, especially when it falls under the $25,000 threshold. There is an elusively thin margin of error with underfunding and short-stacked accounts.
Remedy: The only real remedy is to add more capital to the account. Of course, the notion of building up the account is the goal, but too often traders end up over leveraging and dig deeper holes as buying power continues to shrink with each loss. The respite of zero-commission trading enables traders to play smaller sizes to scale in and out of trades more efficient. For disciplined traders, this provides an edge with the right methodology. However, Intraday traders should have a minimum of $50,000 capital in a trading account.
This pitfall stems from traders who make too many trades and end up giving back earlier profits or turning profits into losses by the end of the day. This is also something can be even more prevalent due to the zero-commission trading era. Scaling into and out of positions with multiple entries is not necessarily overtrading especially if it’s premeditated and purposeful. A sign of overtrading is taking 30 trades to net the same profits that could have been or were made in four trades earlier. It’s sloppy and exhaustive. The worst effect is the more you overtrade, the more your jaded your perspective may get.
Remedy: There are two remedies for overtrading stemming from the cause. If you find yourself overtrading a tight rangebound stock, switch your perspective to a wider time frame chart that visually depicts the tightening (IE: switch from a 1-minute to a 15-minute chart). Secondly, pay attention to the clock. If it’s past 11:30am EST, then you are trading the dead zone, which is the lighted volume and liquidity period of the trading day. With the least amount of market participants, you are the ‘mark’ as algos reign this portion of the day. You will find yourself chasing entries and stopping out quickly as bids and offers tighten up when your out and widen when you try to get back in.
4) The Slow Grind
This is an elusive price move that tends to trap oscillation/reversion traders by snuffing out pullback attempts and pegging the stochastic above the 80-band on uptrends or below the 20-bands on downtrends for extensive periods of time. The culmination of the prior three pitfalls makes traders susceptible to the slow grind. Impulse trading gets them stuck in the position by chasing the initial entries. Having a smaller trading account (short-stacked) limits the ability to scale adequate shares. In desperation, traders usually stop out smaller pieces of the position at the worst times only to re-enter the positions at even worse prices with shrinking buying power. For example, stopping out 1/4th of a short-position at the highs only to step back into the short at the low of the pullback as it resumes the slow grind to new highs. This is an anguishing situation due to the extreme nature of the move. It’s these anomalies that can blow a hole through your account. Often, traders try to rationalize their position rather than react to the price move, which further delays timely actions.
Remedy: Alleviating the prior pitfalls can help minimize getting caught in the slow grind. Most importantly, it’s imperative to understand how a slow grind pattern forms and the small windows of opportunity to trim down or stop out on the limited pullbacks. The one-minute stochastic will be the main tool to use the oscillations down to and through the 20-band to trim out or down shares. Unfortunately, panicked traders will stop out on 1-minute high band stochastics above the 80-band and then get sucked back into the short when the stochastic falls under the 20-band only to get squeezed back up on the next oscillation. The other method is the defensive sprawl, which will be covered in upcoming articles.