Most professional traders tell novice investors not to chase earnings. I have felt that way throughout my trading career. However, I never actually did any statistical work, nor did I come across any papers of statistical work by others, that actually document this fact. That statistical work – or at least some of it – has now been done by us, and the results are presented in this article.
I am sure that there are some readers who will say something like, “What about NFLX? It gapped from 103 to 146 on the earnings report and is up to 186 since the gap move.” Yes, it is, and so that is why we wanted to do this research – to see if maybe the “don’t chase earnings” maxim is wrong – or at least wrong in enough cases that one should look further.
This article will look into a lot of the fact and fiction about earnings gaps and subsequent moves.
First, let’s lay out some definitions and parameters for the study. We have a vast array of stock data in our databases, so it is quite easy to see if a stock experienced a large gap move and to see what happened to the stock price after that. For the purposes of this study, we are concerned only with what happened after the gap move. So in the NFLX case, we would not expect to be involved in the first gap move from 103 to 146. But at that point, any trader can see that the big gap move occurred and can take further action if he so desires...