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A bad earnings surprise is an event
pattern in which a company issues an earnings announcement and the market interprets it as
worse than expected. Nevertheless,
in a bear market 61% have upward breakouts! In a bull market, 43% breakout upward. For those
with downward breakouts, almost
half (47%) bottom in one week, and 60% bottom in less than two weeks. Most of the time, a
bad earnings surprise is nothing
to be worried about providing the stock doesn't make a large intraday move (a wide price
swing). Discovered by Thomas Bulkowski in the fall of 2003. For more information see pages
855 to 867 of the book
Encyclopedia of Chart Patterns,
Second Edition and read the following...
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Important Bull Market Results
Overall performance rank (1 is best): 3 out of 5
Break even failure rate: 31%
Average decline: 13%
Pullback rate: 41%
Percentage meeting price target: 69%
Identification Guidelines
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Characteristic |
Discussion |
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Price trend |
Downward leading to the announcement
for the best performance. |
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Market |
This event pattern works best
in a bear market. |
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Announcement |
The company announces earnings
and the stock makes a large downward move that day or the next if the market was closed. |
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Wide swing |
Look for announcements in
which price makes a large intraday swing, 2 or 3 times the average daily intraday price swing over the last month. |
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Yearly low |
For best performance, select
announcements that occur within a third of the yearly low. |
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Downward breakout |
Since the price trend is downward
leading to the pattern, trade only those announcements making a downward breakout. A breakout occurs when price closes below
the lowest low posted on the announcement day. |
Trading Tips
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Trading Tactic |
Explanation |
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Measure rule |
See the figure to the right. On the announcement day,
subtract the intraday low
(B) from the high (A)
and multiply it by the above "percentage meeting price target." Subtract the
result from the intraday low (B) to get a price
target (C). |
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Confirmation |
Wait for price to confirm
the pattern because traders may push price up instead. A downward breakout
(confirmation) happens when price closes below
the low posted on the announcement day (point B)
in the figure to the right). |
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Longer term |
For investors or traders with
a longer-term investment horizon, do nothing as the decline is likely to be small. However, one bad surprise is likely followed
by another next quarter. |
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Swingers |
For swing traders, consider
selling a holding to minimize the loss. If price gaps downward and the gap is small, price may cover the gap in a few days. |
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Short |
For aggressive traders: In a bear
market, wait for the breakout and then short the stock. It may bottom in less than a week. |
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Quick decline |
Expect a quick but shallow decline.
Almost half the time price bottoms in less than a week and then rebounds. |
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More surprises |
A bad earnings surprise follows
a bad earnings surprise 74% of the time. |
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 The Measure Rule |
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Example
The above figure shows an earnings announcement which the market took as bad news. Price began a strong move up
at point A. When the bad earnings announcement came at B, the
stock was overbought and ripe to fall. Price traded in a large price range on the announcement day and then tumbled
thereafter. Price pulled back, allowing nimble traders to either exit a long position or add to a short position before
the decline resumed. Price dropped from over 70 to 55 and change.
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