The stop-loss is always an important tool for growth and momentum investors (although it’s rarely used by value investors), but never more so than during earnings season. Understanding the best way to use a stop-loss at this time should improve your results.
The quarterly earnings season sends shivers of fear down the spines of investors. It’s that reality check thing again. Stocks can rise on hope, but a bad earnings report can do a Hindenburg on an individual stock and a spate of disappointing results can crush the market’s momentum like a grape.
If you own a stock that misses expectations during earnings season, you have a dilemma. You can always put in a tight stop, leaving enough wiggle room so you don’t get stopped out of a stock that then takes off. But when the news is bad, your little stop will often be swamped in the flood of selling, resulting in a much bigger loss.
2 Alternatives to a Stop-Loss Order
There are several popular alternatives to using a traditional “mechanical” stop-loss (where you’ve entered a sell-stop order with your broker), like using mental stops or mental stops on close.
A mental stop is simply a support level that, if violated, will prompt you to manually sell shares. This offers the benefit of allowing you to manually enter a sell order at a time you feel is appropriate and reduces your risk of getting caught up in a wave of selling that temporarily plunges the value of your shares.
If the shares bounce back immediately once that wave passes, you’ve saved yourself money on the trade. If, on the other hand, that wave was just the beginning of selling pressure, you could also find yourself facing greater losses. Having a sense of prevailing market sentiment and how your particular stocks trade can offer some insight into which outcome is more likely during earnings season.
Mental Stops on Close
Another option, which mutes the noise and intraday volatility of sell-stops and mental stops is to disregard the intraday price action of a stock. In this case, you’ll still establish a support level for each of your stocks, but a violation of that level will only prompt you to sell if the stock closes the trading day below support.
When that happens, it will be a signal to sell during the next trading day, regardless of whether the stock rebounds the next day (in most cases).
This is a better option for long-term investors than for short-term traders. Using the closing price can help de-stress trading stocks that you’re bullish on in the long term at the expense of seeing selling continuation the next day.
So keep your stop-loss (or mental stops) in place and watch the news closely when your companies’ stocks are due to report during earnings season. If you’re not sure when that report is scheduled, you can find it at finance.yahoo.com. Go to the main page for your stock and click on the “Analysis” link on the page. If your company has announced the date for its earnings report, it will show up there. This can help you decide on the best stocks to keep. If you’re looking for a broader resource for stocks reporting during earnings season, Nasdaq offers a useful earnings calendar.
How do you set stop-losses on your portfolio positions?