12 Keys to Trading Earnings for Profits

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#7 Look for the Contrary Indicator

Sentiment can be a contrary indicator.  And the power of sentiment is much greater when it runs counter to the direction of the stock (pessimism during an uptrend, optimism during a downtrend). 

The key to finding the most-optimal earnings plays is to find situations in which expectations are either high or low, and are running counter to the technicals.  This is especially important during earnings season, because sentiment tends to be polarized prior to an announcement. 

• High expectations (low put/call ratio, low short interest, and high percentage of analyst "buy" recommendations) usually require a company to blow out earnings in order for the stock to rally.  Such stocks are vulnerable to disappointments if the company simply meets estimates or issues a tepid outlook for next quarter.
• Low expectations (high put/call ratio, high short interest, and a low "buy" rating percentage) mean that a stock will not have to work as hard to overcome sentiment.  Such stocks are less crowded, and thus have a greater potential to rally. 

Thus, capturing the sentiment backdrop prior to earnings, along with assessing the technicals and the company's past earnings history, are the keys underlying your success.

Let's examine some of these indicators and how you can use them to improve your earnings trading results.