What to do when a stock gaps down after earnings

I had this question today about a stock I don’t trade but someone that follows me on twitter for a long time asked and thought I’d address it with some ideas.

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Initially I told him “Cry and Break a keyboard” which is what most bad traders initial instincts are or to get pissed off , or swear at your computer, blame someone else  etc. etc. etc.

As you can see buzz responded that he tried but it didn’t help – It will initially relieve some of your stress but to last at trading and dealing with gap down stocks is something that you need to do well or you can’t last long term at trading. The emotions will get the best of you if you don’t plan in advance.

How you handle this experience is what will set you apart from the less experienced traders.

If you hold anything into earnings its a always a bit of a gamble. We had talked about this in the Wednesday webinar yesterday-http://stockguy22.com/2013/06/06/mid-week-stockguy22-free-webinars-jeff-rob/

Someone like Rob (@Stockdarts) doesn’t hold any stocks into earnings and prefers to trade the options instead into those events so he knows his max loss and max gain ( as well as his risk/reward ) & it suits his trading style best.

For someone like me that holds both swing trades and longer term trades I balance it out. If I don’t know a stock well then I usually sell prior to earnings. If I like it longer term like my Health Stocks or Dividend plays then I rely more on the fundamentals of a company and use technical analysis as a guide rather than immediate buy/sell points.

So let’s look at the stock in question CLFD – dropped back today at the open : Below is the chart:

What do we see ?

An extended drop past 10amEST on traders panic selling or shorting the stock.  If your plan is to get out and limit your loss and move on to the next trade then I always wait for a bounce point into 10amEST – In this case it happened just after 10:30amEST and you get your bounce and limit some of the extended panic selling. The other plan would be to do an options play to protect you from a further drop but starting a potential puts play in case that $10 tests or breaks down . To me $10 levels are very key levels to watch as both buy/sell points ( in this case it will be our support in case we drop further)

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So that’s how you handle the intraday portion of the play. You either

1) Panic sell with the emotional traders ( which I don’t suggest)

2) Wait for a bounce – get out and move on to the next stock

3) Do an option play to protect you from a further drop but do so on the intraday bounce ( if you aren’t sure how to structure that I suggest you follow or ask @stockdarts or @cerebralTrades on twitter – 2 great options traders that I talk to daily.

So let’s say you still like this stock longer term what are the options for you now?

Again let’s now look at a longer term chart – Our Daily chart to see where CLFD dropped down to:

As you can see we dropped right down to the 50day sma area (pink line on my chart at $10.70) which it extended slightly below before bouncing back went to $10.18 lows today.  This chart gives us a better view and why I like to keep on my screen both a 5min intraday chart like above and a daily chart as you see below since you get  a different viewpoint.

So a few questions I’d be asking Buzz is :

1) if you plan to hold CLFD longer term then just focus on the Fundamentals and hopefully you have not bought this stock prior to earnings and into the recent highs.

2) We see the stock had topped out in June already with the tri-tip Top Tweezer candles ( means 3 tweezers in a row) & had a big drop to the 50day sma which it bounced from . So the stock has already had an extended drop recently so a new drop especially into earnings should not be a shock in this case.

3) If you worry about a further drop sub $10 and you don’t want to stop out just hedge your current position with some $10 puts further out so that you are at least protected from further losses.

4) The stock prior to the big runup in May/June/July was a very lightly traded stock – That light volume alone would have kept me out of this play since stocks under 500K -1M in daily volume tend to have extended movements ( both to the upside as you can see in past pops and to the downside like you see in June and today’s action. If I still wanted to trade a stock with light volume I usually buy less than an avg sized position. I did that recently with AVAV ( A drone stock play that I’ve blogged about in the past) This stock recently popped for me but could have easily gapped down too so what I do is I like the play longer term but I’m aware the lighter volume can cause extreme move for my position ( PLANNING THIS AHEAD OF TIME AVOIDS SOME CRAZY MOVES)

5) Now I would also ask Buzz if you bought this just into earnings expecting a pop then your thesis was wrong and a gamble in my opinion. Much better swing buys are into the 20day sma dips, 50day sma dip in June and there was no reason to buy this into the dip this week since was weaker and had not tested the 20day sma (red line on my chart)

Even if Buzz had bought this stock prior to earnings or into the July run-up the stock should never have been a full sized position. You are trading a stock that has more than doubled in the past few months from $6-$14 and where to take off profits should have been more the concern not to try to buy and hope and pray for a gap up to $14-$15+  Again this is very important and applies to stocks into this huge market runup we’ve had. WHY WOULD ANYONE BUY  A FULL POSITION (LONG TERM OR SWING ) after major runups. I understand that some traders love trading momentum and breakouts but its a more dangerous game after market runs like we’ve seen. This stock should never have been a 1/3 or 1/2 size if was bought over $10 & if it was bought over that level some profit should have been locked up into that key $13+ -$14 that is a 30%-40% move in less then 1 month .. WHY WERE YOU NOT REALIZING THAT ? is more important question I would want buzz to answer.

 

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So now let’s look at the fundamentals if Buzz plans to hold this play

1) Now I’m sure BUZZ did not have  a full position so if he is still willing to hold this stock longer term and has  looked into a hedge sub $10 since that’s the scary level to watch for.

2) Fundamentals are not so bad I’ve included them below : Any company can miss earnings in a Q but if the thesis is longer term then adding once this stock bases or if it holds over $10.70-$10 is the perfect add point for that scenario. So buy when these other traders are panic selling, but let the stock settle first ( a few days -week it may take) If you miss an additional add and gets away from you over $12 then I would not chase it for further adds but keep it on the radar for the next major drop.

3) Let’s tear apart a few of the Fundamentals.. The company has no debt, has $15M in cash, has turned profits for the last 5 years after having losses for the previous 5 years ( although each year the losses narrowed). The Sales have also gone up but there is only consistency on net income growth  for the last 2 years. To me that’s a red flag of inconsistency and I would not justify this as longer term play for my personal trading style. Also the company is too small for me to trade its only $140M market cap and most of the stocks I trade longer term are much bigger. I may swing trade it but I would never own this longer term since doesn’t fit my conditions.

4) So you see the detail I go into when I want to own a stock longer term.

5) In trading you have to find your own trading style that suits your risk-tolerance , risk-reward criteria and many other factors that I won’t discuss in this blog. Its stuff we review in our Summer Mentoring webinars and that I help when I teach traders the simple strategies like this that have  worked for me over the many years I’ve been trading.

Once you find that trading style and combine it with average sized positions, a knowledge of Technical and Fundamental Analysis, it will help you greatly before you even start a trade.

Didn’t check for typos since put it together quickly into lunch time so hope you get some knowledge from this.

YOU CAN’T AVOID GAP DOWNS COMPLETELY UNLESS  YOU HOLD NO STOCKS INTO EARNINGS and even if you don’t — an expected intra-day drop or halt can also happen but as you can see we had some tell tale signs that this stock should never have been a full position so Planning that TRADE well in advance can help limit losses.

In conclusion don’t worry about what you can’t control — THE GAP DOWN!

Worry about the stuff you can control –

TECHNICAL ANALYSIS ( learn to read charts better like i posted above about support/resistance levels)

FUNDAMENTAL ANALYSIS (understand a company’s health better)

OPTIONS ( if your account is large enough use options to hedge positions better)

POSITION SIZING ( scale in and out better)

GET INTO THE HABIT OF TAKING OFF PROFITS INTO BIG RUN-UPS (even if its too soon you can add back on dips since no stock goes straight up)

DON’T PANIC

LEARN FROM YOUR MISTAKES

MOST IMPORTANT —- PLAN YOUR TRADE  –

You can see from what i posted CLFD had all the red flags that would keep me out of this trade into earnings.

Hope you found this helpful

Stockguy22

 

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