Analyzing Earnings Day Gap Ups

Fellow trader @Tone recently asked a great question worthy of further investigation.

I like the setup where earnings happens after 4pm, and the stock gaps up a/h. The next morning, these can sometimes rip (ROKU, DMRC) but can sometimes tank (RH, LULU). Do you have any insight (from a technical perspective) to forecast the likelihood of the direction at open?

Source: Profit.ly

This makes me wonder two things: 1) Is there any opportunity for profit immediately following an earnings gap up? 2) If so, what can we use as a trigger or signal to determine our entry?

First, lest’s take a look at the symbols he mentioned: $ROKU, $DMRC, $RH, and $LULU.

I can start to see a pattern here with these four charts. The stocks that moved up from the open on earnings day never had a significant move below the pre-market low, and always crossed above the pre-market high. The inverse is true for the stocks that moved down from the earnings day open. I say “significant move” because there were a few prints outside of the pre-market range, but nothing meaningful enough to produce a trend.

So is it as simple as drawing two lines and going long or short depending on which side of the range gets breached? Let’s test this theory against every Q2 earnings announcement that resulted in a gap up of at least 2%.

For this, I’m going to use the trade-ideas “Odds Maker” backtesting tool. On the long side, let’s initiate trades in the first 45 minutes of the session and either hold for 30 minutes or take a 10% gain/2.5% loss, whichever comes first.

Now let’s take a look at the results (60 day test) when using a new day high as our trade signal and a few other filters including (but not limited to) price < $300, daily volume > 25k, and stocks that are trading in the top 10% of the pre-market range.

It looks like our long thesis worked out pretty well. The strategy returned just under 20% in 60 days, with a +2:1 risk/reward and a very strong win rate. Thanks to Tone I’m now running this strategy in my auto-trading platform, and have already made some money. Check out my latest trade on $CDMO.