Earnings Report Trading Strategy (Backtest)

Last Updated on September 22, 2022 by Oddmund Groette

Of course, companies release their earnings reports every quarter. If you are a short-term trader, you may have wondered whether to buy a stock before or after the release of its earnings report. But what is the earnings report trading strategy?

An earnings report is a financial document that every publicly traded company is required to release every quarter and year-end, which shows its expenses, earnings, and overall profit for the period under review.

Here, we take a look at earnings report.

What is an earnings report?

An earnings report is a financial document that every publicly traded company is required to release every quarter and year-end, which shows its expenses, earnings, and overall profit for the period under review. Investors analyze the report to assess the company’s financial health so as to make informed investment decisions.

Earnings reports provide a periodic update of a company’s financial statements, including its income statement, cash flow statement, and balance sheet. In the US, public companies are mandated to file Form 10-K or 10-Q with the Securities and Exchange Commission (SEC) at the end of every quarter. In the forms, they report their performance for the period under review, which would be released to the public.

In general, an earnings report contains the following:

  • The period under review
  • The company’s details, including its tax identification and the location of the main business
  • A summary of the company’s earnings statement, cash flow statement, and balance sheet
  • Synopsis of the preceding period and the same period of the preceding year
  • An analysis of the company’s performance and operations by the management
  • The company’s present and future expectations and the results of the business operations
  • Qualitative and quantitative disclosures about market risk
  • The procedures and methods used to ensure that the financial information is accurate

Should you buy before or after an earnings report

Evidence suggests that it makes no difference whether you buy a stock before or after earnings are announced. While there may be increased volatility following the release of an earnings report, on average, a stock’s share price does not rise or decline more after an earnings announcement than on any other day. There is no correlation between share price changes and whether the report beats or misses the earnings estimates.

However, this is based on the average of 30 stocks on the Dow 30 Index. Some stocks will jump after earnings and some will fall, but on average these changes cancel each other out. You need to back-test to see what happens with the stocks you are trading. However, to minimize risk, you need to have a diverse portfolio of stocks.

When to sell after an earnings report

The market is very erratic. You can’t just guess and expect a good result. The only way to know what works in the market is to test different ideas to find what works. So, to know when to sell after an earnings report, you have to make a specific testable strategy and back-test it to know if it has a statistical edge with positive expectancy.

How do you trade based on earnings reports?

After earnings reports are released, some stocks will jump, while others will fall. While it may seem like it depends on whether the earnings beat the estimates, that is not always the case, as investors consider a lot of different factors and react differently.

There are many ways to trade, but the question is, which one of them gives you an edge in the market? You need to make your research, come up with ideas, and back-test them to find the strategy that gives you an edge.

Dow Jones earnings report strategy

Cassidy Cornblatt researched stock changes after earnings announcements using the most recent 4 quarterly earnings reports for all 30 stocks in the Dow Jones Industrial Average (DJIA) index and found that the average change was -0.2% with a standard deviation of 4.1%. In comparison, the average daily change in the DJIA index for 30 random dates over the same period was -0.1% with a standard deviation of 1.0%.

Earnings report trading strategy
Earnings report trading strategy

Source: Cassidy Cornblatt

This means that there is essentially no change in stock prices on average after earnings are announced. So, while the prices of individual stocks do appear to be more volatile after earnings, based on the standard deviation, it makes not much difference if one has a portfolio of all the stocks in the Dow 30 Index. The best way to achieve that is to trade the SPDR Dow Jones Industrial Average ETF, which tracks the performance of the index.

Earnings report trading strategy (backtest)

An earnings report strategy is coming soon.

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