Although I had been trading for some time, I always had the same struggle many traders have. This is the challenge of how to build the best list of stocks to trade to increase your odds of being in a successful trade. As a technical chart pattern trader I look for certain chart patterns that offer a high probability of success if the pattern is broken in a positive way (for longs) or a negative way (for shorts). Finding these patterns has become very easy these days. Just watch the charts that are continuously posted by traders on the Stocktwits stream. There are so many there that look good we should all be rich and famous. In fact, there are so many to choose from where do you start? You can’t possibly trade them all.
If you have been trading technical chart patterns for a while you realize that in may cases the patterns that looked so good in advance failed miserably shortly after you got into the trade. As an example, in 2008 Thomas Bulkowski studied the failure rate of 14,000 “long” chart patterns in the Bull Market of 2003 to 2007 and found the failure rate to be 28%. To be successful as a technical trader you need to define an edge that works for you. The edge is a method of building a list of stocks to trade that will increase the probability of the technical pattern playing out in your favor. If you just randomly grab chart setups off Stocktwits, most likely Murphy’s Law will prevail on the stocks you choose to trade and those will be the patterns that fail. There are many methods you can use to get your edge. Maybe you trade stocks in strong sectors. Maybe you jump on news stories. Maybe if in the upcoming State of The Union Address the President mentions some sector focus for the coming year and you look to trade the stocks in that arena. Maybe you just have a set list of stocks that met some criteria you defined and trade technical setups on just that list. My core list and what I feel provides my edge is based on the PEAD concept.
PEAD stands for Post Earnings Announcement Drift. I was first introduced to the PEAD concept several years ago by Pradeep Bonde when I joined the Stockbee Service where the focus is on developing solid methods for being successful at trading. The PEAD concept was first described in a 1968 academic accounting research paper by Ball and Brown and further explored in detail in a 1989 paper from Bernard and Thomas. I will provide some additional links to articles about PEAD for you to explore at the end of this post but the basic premise of PEAD is….
“Post Earnings Announcement Drift (PEAD) is the tendency for a stock’s cumulative abnormal returns to drift in the direction of an earnings surprise for several weeks (even several months) following an earnings announcement.”
If there is an earnings surprise and the stock pops up, it has a high probability of continuing that move up for quite some time. When I thought about PEAD as an edge it just seemed so intuitive. Since, in my mind, the driver of most longer term moves in a stock price is usually growth in revenues and earnings, why not make upside earnings surprise the core strategy of defining your edge? For the past few years I have defined my core strategy as being PEAD based and I built my list of stocks to look for technical setups from those that have had earnings surprises and price pops as a result. Once I have built the list I will watch those stocks daily waiting for them to set up a continuation pattern to trade such as a horizontal consolidation or flag.
Being successful at trading is not easy, it takes hard work and lots of preparation. Once you define your “edge” also known as your method, you need to do the work every day to find only the best trades to deploy your assets in. One way to start implementing the PEAD concept is by using the Earnings Whispers site. Even without a premium subscription you can visit the site or subscribe to a free email that tells you the earnings beats or misses for each day. Then it’s up to you to track those that had a surprise beat or miss for follow on setups. If you search you will find earnings data from a variety of sites and services out there.
Recently I have been using a premium service from The Patient Fisherman called Bluefin to save me time in building the PEAD list. In Bluefin they are called the Post Earnings Surprise lists. Bluefin provides two lists that are continually updated. The first list contains stocks that in their most current earnings announcement they exceeded the analysts earnings per share (eps) estimate by at least 25%. The second list contains stocks that had a price move of 6% or more on the day of their earnings (with The Patient Fisherman’s permission, here is the 6% list published on 22 Jan 2012). I have found these two lists to provide more than enough opportunities to trade on a regular basis. I start with these lists and filter them so that I only have stocks that are over a minimum price and trade on average a certain amount of shares per day. Once the list is narrowed down I review it every day and set trading alerts on the best technical setups I can find that match my style.
Here are a few examples of stocks on the list that show successful follow on technical setups.
The above stocks are just a few of a large list. Not all work out as planned but if they trend and set up technical entries the PEAD effect increases your odds of having the trade be a profitable one. If you start making a list and monitoring the PEAD stocks you will find that they are often mentioned by others over time after they make a continued move. By doing your homework and monitoring the list each day you will be in the higher probability setups.
If you search the internet you will find many articles discussing PEAD. Here are a few to start with.
From Stockbee’s public blog
From Phil Pearlman’s Stocktwits Blog
From Matthew Weinschenk at Investment U
Regardless of whether you incorporate PEAD into your strategy or not, the most important thing is that you define your edge and have your own methodology to find the proper stocks to trade and the proper entries, exits and stops. Random approaches do not work and following others does not either. Be a professional and treat this as a business. The harder and smarter you work the luckier you get.