The pain was shooting right to my brain.
I literally had to step back and just cringe for about a minute until it eased off.
This happened just as I thought I was finally old enough, and smart enough, to avoid a brain freeze while eating a popsicle.
But standing in nearly 90-degree weather watching a show at Cinderella Castle in Disney’s Magic Kingdom park last week, the popsicle was melting too rapidly for me to consider a brain freeze.
My immediate satisfaction took place over common sense.
We can make the same mistakes in trading, and like brain freezes, it doesn’t matter how long you have been an investor — mistakes are still made.
Today, I’ll talk about the common mistake of chasing gains.
Laying It All on the Line
We all have seen monster gains that we end up striving for.
Gains that you are so excited about you forget some commonsense investing principles and lay it all on the line. Typically, this ends up resulting in severe losses you were not ready to take. Like eating a popsicle in 90-degree weather and experiencing a brain freeze for the first time in decades.
There’s always someone talking about some remarkable trade that they have made. Or we are looking at a stock that has jumped 10,000% in the past decade, and we seek to find one that will do the same.
In the options market, you can routinely find options that have jumped 1,000% or more in a single day.
That’s a remarkable return over any time frame, but practically unheard of in one day for stocks.
Yet, if you go through your brokerage account during earnings season and pull up option chains for some fast-moving stocks, you’ll end up finding several options that are up 1,000% or more.
Seeing that many of these 1,000% gainers come during earnings announcements, it leads to a common but failed practice of buying options prior to earnings.
Investors are simply chasing gains instead of implementing sound, proven strategies to steadily build up their portfolio.
The dream of basically hitting the jackpot on one trade is enough to keep people doing it, even though almost all of the time they end up with significant losses.
It’s just like hitting it big at a casino. A few people will hit a winning trade and brag about it — but they will never tell you how much they lost to get that one winning trade.
Over any string of trades betting on earnings announcements, the odds of you coming out ahead are basically the same as you winning the lottery — minimal.
A Wasted Effort
So how do you overcome this common mistake of chasing gains?
Well, the easiest solution is to test your ideas.
Even if it is to trade a stock’s earnings announcement, with the wealth of data we have, you can go back in time and see if your strategy would have worked. Just be sure to test it on various stocks and scenarios, not just on one stock over a short time period.
But odds are, it’s a wasted effort. Because you’ll always be chasing those 1,000% gains you can see overnight.
I admit I have spent quite some time trying to figure out how to predict an earnings announcement. I never found anything that worked by betting on earnings. And I have followed numerous others who set out to discover a way to make money before earnings were announced … and they too have failed.
What my research and testing did lead to is a strategy I call Earnings Drift Alert.
With Earnings Drift Alert, I don’t gamble on what will happen on an earnings announcement. Instead, I use historical analysis to confirm which direction the stock will drift in the coming months.
That’s the best way to trade earnings.
Chad Shoop, CMT
Editor, Automatic Profits Alert