Watch for Gaps During Earning Season
Earnings season can be a volatile period for stocks which either disappoint on earnings or beat earnings estimates. This volatility can create opportunity, and stocks that gap up are a good example. A stock that gaps up may appear to high to buy, and the trader may feel like the opportunity was missed. On the other hand, upside gaps make it easy to identify which stocks are on the move.
During earnings season, scan for stocks with upside gaps, and then check to see if earnings were reported that day, or the day prior. Next, see if the stock gapped out of a range pattern, above resistance. This is important. Weak gaps, or gaps below resistance, are not the best candidates. Facebook (FB) gapped up off the 50 EMA on 30 Janaury 2013, and it is a good example to study.
On Wednesday, 29 January, FB reported (after the close) a 63% increase in revenue for the fourth quarter of 2013. The stock was up in after hours trading that day. Then, on Thursday's open, FB gapped up 16% on 2.3 times the average volume. The stock also cleared the resistance line of the range pattern.
The best gaps to trade occur in stocks that have a prior history of strong earnings growth, so check fundamentals before buying. Volume is an important factor. Look for volume which is 1.5 times average or more. Strong volume means strong commitment by institutional investors.
Stocks which gap up may decline to retest the prior resistance for support, or they could move sideways before going higher. This allows plenty of time to make a good entry.