Welcome to Quantra Classroom. Today, we will discuss an important strategy that day traders can deploy. The strategy is Post Earnings Announcement Drift (PEAD).
The results of applying this strategy on Apple stock from May 2018 to October 2019 is shown below. The Python code for the strategy is available here.
Earnings Releases
An earnings release is a report that a company releases to the public detailing its financial performance for a specific period. Typically, companies release earnings reports on a quarterly basis, although some may do so on a semi-annual or annual basis. These reports provide investors and other stakeholders with important information about the company's financial health, including revenue, earnings, and profit margins.
Why Are Earnings Releases Important?
Earnings releases are important for several reasons. First, they provide investors with valuable information about the financial performance of a company. This information can be used to make informed investment decisions, such as whether to buy or sell shares of the company's stock.
Second, earnings releases can impact the overall stock market. When a company reports strong earnings, it can boost investor confidence in the broader market, leading to higher stock prices. Conversely, if a company reports weak earnings, it can cause investor sentiment to turn negative, leading to lower stock prices.
Post Earnings Announcement Drift (PEAD)
Post Earnings Announcement Drift (PEAD) is a phenomenon that has been observed in the stock market. PEAD refers to the tendency of stock prices to continue to drift in the direction of an earnings surprise (either positive or negative) for a period of time after the earnings announcement.
For example, if a company reports higher than expected earnings, its stock price may increase immediately after the announcement. However, research has shown that the stock price may continue to increase for a period of time after the announcement, as more investors become aware of the positive earnings surprise and adjust their investment strategies accordingly.
Conversely, if a company reports lower-than-expected earnings, its stock price may initially drop. But the price may keep declining for a while as more investors learn about the negative news.
How to trade Post Earnings Announcement Drift (PEAD)?
In the strategy, we won't have to judge whether earning is good or bad. We let the market movement tell whether earning is good or bad and trade accordingly.
For example, Apple (AAPL) released 7 earnings reports between ‘2018-05-02’ and ‘2019-10-31’. As per PEAD, the sentiment persists for a few days after the earnings announcement. Thus, if the market closes higher on the earnings announcement day, a long position can be taken at the opening of the next trading day. Similarly, if the market closes lower on the earnings announcement day, a short position can be taken at the opening of the next trading day.
How can we improve the entry conditions?
We can take a long position if the return on earnings announcement day is greater or equal to 0.25 times the 90-day moving standard deviation of the return. Similarly, we can take a short position if the return on earnings announcement day is lesser or equal to 0.25 times the 90-day moving standard deviation of the return. In both cases, the trades are closed at the close price of the same day. The numbers 0.25 and 90 are taken only for illustration purposes.
The following graph represents the cumulative returns of the PEAD strategy on AAPL stock between ‘2018-05-02’ and ‘2019-10-31’ using the entry and exit conditions mentioned above.
The graph shows that if you had invested $1 in this strategy on May 2018, it would have returned $1.036 by November 2019.
Now, you might think that this performance is abysmal. But you must understand that you are allocating your capital once every quarter.
Thus, while it looks like a low-return strategy, it is also a low-risk strategy which gives you optimum performance. Not to mention, we are closing the positions on the same day.
Sounds exciting, right? You can also check if there is an impact on the performance depending on the number of days the position was held.
You can get the Python code for this strategy from this unit of the Day Trading Strategies for Beginners course on Quantra. You would have to enroll into a free preview of the course to access the Python code. See you in the next Quantra classroom.
Disclaimer:
This post is for educational purposes only and is not a solicitation or recommendation to buy or sell any securities. Investing in stocks involves risks and you should seek the advice of a licensed financial advisor before making any investment decisions. Your investment decisions are solely your responsibility. The information provided is based on publicly available data and our own analysis, and we do not guarantee its accuracy or completeness. By no means is this communication posted as the licensed equity analysts or financial advisors and it should not be construed as professional advice or a recommendation to buy or sell any securities.
