The trading method described here is an adaptation of the system described in Chapter 11 of the book "Explosive Stock Trading Strategies". The objective of this trading method is :
(1) To identify high probability winners before earnings announcements
(2) To pinpoint a low risk entry point so that even in the unlikely occurence of a negative earnings surprise , our loss will be very limited.
The entry point is determined by three signals (1) A narrowing Channel. (2) A bullish Crossover . (3) A positive divergence .
The first two charts show situations where this system worked with a strong gap up after earnings , The last chart shows where this system failed with a strong gap down after earnings. Notice that even with the strong gap down our loss is quite small or close to break even.
The way I trade this signal is as follows:
(1) Check for stocks coming up with earnings at least 14 days after you identify the stock. Example: If you check on March 14, only pick stocks with earnings on March 28 or later
(2) Stick with stocks above $10 , preferably above $15.
(3) To minimize risk look at what the prior quarter's earnings looked like. If there was a negative surprise stay away.
(4) Enter based on the signal below. ALL three conditions must be satisfied.
(5) Use options to make a profit even if there is a negative earnings surprise as follows:
In the majority of situations the stock will move up based on this signal prior to earnings. As an example CIEN moved from our entry of $17.25 to $21+ prior to earnings. What I do is that a day or two before earnings I will buy a protective put expiring at the closest time after earnings. This is very effective for stocks trading weekly options.As an example for CIEN I would buy a $20 strike put, for ULTA a $160 puts, and for FNSR a $ 14 put .
To illustrate the big advantage of using weekly options, the earning for FNSR came out Thursday March 10 after the close. I thus bought a $14 strike put options during the day on Thursday expiring the next day Friday. Due to the minimal time value of the option the cost of the option was low, thus giving good downside protection.Of course I will lose 100% of the protective put but with the stock moving over $17 , I made several times that in profit.
In the Chart For ULTA , our entry is signaled around $152 with a move to $190 after earnings.
In the chart for FNSR, our entry is signaled around $12.25 with a move to above $17 after earnings
In the chart below for CIEN , our entry was signaled around $17.25. The stock moved up to $21 but then gapped down on bad earnings to near our purchase point . Our low risk entry
saved us from a big loss.