Holding a stock through its earnings report

Most of the time, a stock’s price moves the way a person walks: one step after another. If it’s going to fall from $100 to $90, it passes through $99, $98 and $97 on the way, and at each of those prices somebody can sell. That’s the world a protective stop is built for. You say “sell if it gets to $95”, it gets to $95, and you’re out at roughly $95.

An earnings report breaks that. Four times a year a company publishes its results, nearly always while the market is closed, and the next morning the stock opens wherever the news has put it. It doesn’t walk there. It’s at $100 when the market shuts and $88 when it opens, and no price in between ever existed.

What that does to a stop

Say you own 40 shares at $100 — $4,000 — with a stop at $95. You’ve decided the most you’re willing to lose on this position is about $200, and on any ordinary day that’s what the stop delivers.

The company reports after the close on Thursday and the results disappoint. On Friday the first trade is at $88. Your stop was waiting for a price of $95 or lower, and $88 qualifies, so it sells — at about $88. You’ve lost $480, not $200. Nothing malfunctioned. A stop is an instruction to sell at the next available price once a level is crossed, and the next available price was $88.

This is the single most useful thing to understand about stops: they limit a loss that arrives gradually, and they do not limit one that arrives all at once. Earnings are the most common way a loss arrives all at once, and the helpful part is that they’re on a calendar.

How big is the jump, usually

It depends heavily on the company. A large, steady business might typically open 2–3% away from its previous close after a report. A smaller or faster-growing one can routinely move 10% or more. The move is as likely to be up as down — a gap is a coin flip with a company-sized coin.

A reasonable first estimate is what the stock did after its own last few reports. It’s a rough guide, not a forecast: four past reports is a tiny sample, and the report that matters is always the one that surprises people.

Three honest ways to handle it

Hold through it, on purpose. If the position is small enough that the company’s typical jump — or a jump twice that size — is a loss you’d accept, holding is a perfectly good decision. What makes it good is that you sized it knowing the stop wouldn’t help. $4,000 in a stock that typically moves 5% is a $200 coin flip; $400 in the same stock is a $20 one.

Reduce before the report. Selling half turns a $200 coin flip into a $100 one and keeps you in the trade if the news is good. It costs you half the upside too, which is the trade-off, stated plainly.

Step aside and come back. Close the position before the report and look again afterwards. You give up the chance of a lucky gap up, and in exchange the one event your stop can’t handle simply doesn’t apply to you. Many short-term strategies do exactly this as a rule, because a rule that was tested on ordinary days says nothing about what happens on an extraordinary one.

There’s no fourth option where the stop saves you, and that’s really the whole lesson.

The releases that move everything

Company earnings affect one stock. A handful of scheduled government releases affect all of them at once: the Federal Reserve’s interest-rate decisions, the monthly inflation report, and the monthly jobs report.

They behave a little differently. The inflation and jobs reports come out at 8:30 am, an hour before the market opens, so they act like a gap — but only on positions you held overnight. A Federal Reserve decision lands at 2:00 pm with the market open, so prices move fast but continuously, and a stop works the way it normally does. Knowing which kind of day it is tells you which of your positions are actually exposed.

What trips people up

It’s natural to look at a stock that has risen nicely into its report and feel that the stop underneath it has locked in the gain. It hasn’t; it has locked in the gain against an ordinary decline. The habit worth building is small: before holding anything overnight, know whether the company reports before the next open. If it does, the question isn’t “where’s my stop?” — it’s “how much am I comfortable having on this coin flip?”