How You Can Profit from Buying the Dip
Earnings season is a great time to focus on dips, but investors need a game plan to get the most out of upcoming opportunities. Jeremy goes over a few technical...
Now that stocks have pulled back from all-time highs, investors are wondering how to maneuver their assets going forward. For those exposed to the market surge since March of 2020, it has been very rewarding. From the pandemic lows to September highs, the S&P was up over 100%, while the Nasdaq surged 135% higher.
If you played it perfectly, these returns came in just sixteen months!
For those who overlooked the opportunity, there is now an urge to catch up with the rest of the pack. If you are in that camp, I know what you’re thinking…
How did I miss out on 100%?!
Maybe you were too cautious because you didn’t feel you knew enough about stocks. Maybe it was nervousness about the uncertainty surrounding the virus. Understanding yourself and the psychology behind why you missed out is important. But more important is NOT missing the next opportunity, and NOT being fearful to take the risk that comes with nailing that move.
Sometimes it just comes down to BUYING THE DIP!
As we approach the fourth quarter, it is paramount to have a game plan going into the end of the year. Now that we have seen an aggressive pullback, we will likely see some consolidation, before ultimately moving higher. Any further upcoming pullbacks will be caused by market events that will be fueled by anxious bears. This is the time to strike!
Below I talk about upcoming market risks that are currently bringing the market lower. We will then dive into why buying the dip often works and talk about some strategies to follow. Additionally, we will focus on the timing of buying the dip and how earnings season is a great time to focus on dips.
Short-term Market Risks
Market sell-offs are caused by changes in the economy that hint growth and momentum will slow. The recent sell off in the market has been caused by multiple issues that are making investors nervous. When these risks pass, markets often bounce aggressively.
1) Taper/Rates: At the last Fed meeting, we saw rates starting to move higher and they haven’t stopped. Tapering, or the reduction of the Fed’s bond buying program, is starting soon and the Feds next focus will be lifting rates. It looks like the market is jumping ahead of that idea, as the 10-year note recently moved above 1.5%.
2) Inflation: Prices for goods are going up and if inflation gets out of control, the Fed will be behind the curve. Lately, we have seen energy prices move up quickly, with natural gas, crude oil and coal prices accelerating higher. The risk here is higher prices that consumers would have to pay during a cold winter.
This could be a massive “tax” that would hit global economic growth, creating a stagflation type economy. This is not just an energy issue and CPI data will be extremely important going forward.
3) Supply Chain: In almost every industry, we are seeing supply chain issues persist, which slows down commerce. Future earnings growth could be affected, not by consumer demand, but by the ability for a company to get consumers the product.
4) Debt Ceiling: The debt ceiling is back and the political rhetoric between Democrats and Republicans is stronger than ever. While it would be a big deal to default on our debt, Congress always ends up raising the debt ceiling. Until they do, markets will be nervous.
More . . .
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Buying Stocks on a Dip
When markets sell off, we can utilize the Zacks Rank to separate the weaker stocks from the profitable ones. By combing the fundamentals of the Zacks Rank and technical analysis, investors can decipher which stocks to buy and which ones to ignore.
This strategy often works because when the smoke clears, investors pile right back into the companies that are fundamentally outperforming. So the real question is when and how to buy these names when they fall.
Below are some technical strategies commonly used when markets dip:
1) Moving Averages - The two most watched moving averages are the 50-day and the 200-day. These are common levels that long-term investors watch for support. So, when a sell off reaches these points, buyers usually step in.
2) Fibonacci Retracements – You remember Fibonacci from high school, right? He’s the guy that came up with the golden ratio and noticed predictable patterns all over nature. The mathematician unknowingly gave us levels in the charts that can be drawn to find entry points and profit targets.
A Fibonacci retracement can be found by drawing recent lows to highs or vice versa. When stocks see 50% and 61.8% retracements, they usually see support as they are commonly watched levels that investors look to buy the dip.
3) Volume - When volume spikes to unprecedented levels it usually means there is some capitulation in the markets. This often marks the bottoms of a move, or will signal that the market is close to a bottom.
The Beauty of Earnings Season
Let’s review a common scenario investors come across as they wake up to their portfolio in the morning:
The Dow is up 250 points; it’s going to be a good day.
Stock A is up 1.5%. That was a good pick!
Stock B is up 2.3%. What a beast!
Stock C is down 10% and falling fast! What the heck???
It turns out stock C reported earnings above expectations, but investors are not happy. So, what happened?
Often a company will have a conference call and issue guidance for the quarter or year ahead. This gives analysts, traders and investors a clear picture of what to expect in the coming quarter.
If the stock has run up 35% over the last six months and one little thing is wrong with the quarter, the stock will get slammed, sometimes falling over double-digit percentages.
In today’s modern markets, computer algorithms can actually read headlines and trade off of them in a heartbeat. These computers can react quicker than humans, often causing irrational moves higher or lower. The big moves can lead to human panic as they see their stock dropping fast and their losses adding up.
It’s hard for humans to win the speed game, but with patience and a little discipline, investors are taking advantage of the irrational moves the computer traders create. Buying a stock after earnings move lower is a strategy working over and over again for many traders.
These post-earnings bounce plays can lead to 10-30% gains in a matter of months, weeks or even days!
How to Trade Post Earnings
Whether you are trading earnings before or after the number, knowing who is reporting is key. Paying attention to the list of companies reporting every week is a good start. This list can be found via the Zacks earnings calendar.
Additionally, use these steps below to find ripe opportunities after a stock has reported earnings.
1) Watch for Moves in the Zacks Rank – The first step I take is to check the recent Zacks Rank #1 (Strong Buy) stocks every morning. When I see a fresh stock on the list that has recently moved lower in price due to earnings, I get interested. I then check the EPS numbers and guidance to make sure there was no big negative signal. If not, I go on to the estimates page for the stock and see if analysts are taking the numbers up or down.
Why would investors sell a stock when analysts are raising estimates and still bullish? Well, this makes me think there is some manipulation brewing and the stock has moved irrationally lower.
2) Check for Technical Support - After the fundamentals check out, it’s time to look at the chart. Moving averages, trend lines and Fibonacci levels are used as support levels by computer and human traders alike. If I see a level tested and support is confirmed, it’s time to buy.
3) Entry Price, Target, and Stop Loss - Entering the stock takes patience, but it’s important you get in at a decent price. When entering a trade, you should have a target, or even multiple targets, where you will sell and close out a winning trade.
Capital preservation is paramount. Stop losses are important for investors and traders so they can live to fight another day. You must not get married to a stock! Taking losses are just as important as taking winners and stop loss orders assist in that discipline.
How to Fully Capitalize
The current atmosphere is not your typical stock trading environment. The Fed is starting the tapering talk and the supply chain/inflation dynamic is forcing stocks lower. This combination of risks could cause outsized earnings moves later this month.
The opportunities into the end of the year will be plentiful due to the recent volatility. The mission of my portfolio, Zacks Counterstrike, will be to catch these big moves, playing both the long and short side of the market.
I plan to be in before and after earnings depending on the situation and look forward to capturing the big moves that are coming our way. The upcoming quarter will be important for stock prices, so join me and let’s profit from it!
Our goal: Quick and consistent profits.
For example, we recently closed gains of +40.2%, +49.1% and +62.0%. One even closed at a remarkable +252.0% in less than a month.¹
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Editor of Counterstrike
Jeremy Mullin is a stock strategist who combines the fundamental power of the Zacks Rank, technical analysis and computer driven trading to find the best trades. Discover all of his current recommendations in Zacks Counterstrike.
¹ The results listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research's newsletter editors and may represent the partial close of a position.
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