The Earnings Gapper Trade Setup

With earnings season in full swing, now is a good time to look at one of my all-time favorite trading setups. 

In my view, a company’s quarterly earnings report is the most important factor for how its stock will trade in the near future. The quarterly earnings report sets the tone for how the stock will trade for the rest of the quarter. 

Often times, you will see the strong momentum from an earnings beat carry over for the remainder of the quarter (until the stock announces its next quarterly report), and vice versa for negative momentum on an earnings miss. This is because institutions typically accumulate a new position over a spread-out time frame that can last weeks to months. It is not a 1-day ordeal. 

This can present some of the best trading opportunities for astute traders. In the post-March 2020 Bull Market, many of my personal best trades came from such opportunities. Below, I will dive into some examples of earnings gappers and accompanying trades I made:

FSLY Q1 Earnings Gap – 5/6/20

On May 6th 2020, FSLY FSLY announced a blowout quarter. The company beat on Q1 revenue estimates by 8%, while guiding 23% above consensus revenue estimates for Q2 and 12% above FY revenue estimates.

The stock opened up +27.4% the day after its earnings announcement, but the big move was just beginning. Below is the FSLY 5 minute chart on 5/7/20 to show the entry:

On this trade, FSLY gave a textbook inside 5 minute entry on the 3rd candle of the day. Traditionally, for inside day/inside candles, the stop is placed at the low of the inside candle. However, for these types of earnings gap trades where volatility is heightened, I prefer to use the low of the day for the stop loss (provided the risk is <10%) to avoid getting stopped out on normal post-earnings action. 

On this trade, the entry was at $27.91 on the inside 5 minute break. The stop was placed at the low of the day ($26.63) for -4.6% risk. 

I have found that for earnings gappers opening up +15% or greater, it is best to look for an initial pullback once the market opens. For FSLY, the inside 5 off the initial pullback provided an easy entry opportunity. This was exactly how you hope to draw it up (and I wish they were all this easy).      

Remember how I said “often times, you will see the strong momentum from an earnings beat carry over for the remainder of the quarter (until the stock announces its next quarterly report)”. This is exactly how it played out for FSLY, with the stock reaching a high of $117.79 the day before its next quarterly earnings announcement.  

DDOG Q1 Earnings Gap – 5/11/20

On May 11th 2020, DDOG DDOG announced a major beat and raise quarter. The company beat on Q1 revenue estimates by 12% and turned a surprise profit on the bottom line. Moreover, DDOG raised Q2 guidance 12% above consensus expectations.

The stock opened up +11.1% the next day after its earnings announcement, but again, there was plenty of meat left on the bone here. Below is the DDOG 5 minute chart on 5/12/20 to show the entry:

Similar to the FSLY trade above, DDOG gave a textbook inside 5 minute entry on the 3rd candle of the day. Again, for these types of trades, I prefer to use the low of the day for the stop loss (provided the risk is <10%) to avoid getting stopped out on normal post-earnings volatility. 

On this trade, the entry was at $65.28 on the inside 5 minute break.The stop was placed at the low of the day ($61.04) for -6.5% risk. 

Similar to the FSLY trade above, the momentum from DDOG’s beat and raise quarter propelled the stock all the way into its next quarterly report.The stock hit a high of $99 two months after the earnings gapper move.

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Summary Rules – Earnings Gapper Trading Strategy

1.       Stock gaps up on Big Earnings Beat and Guidance Raise (key!!!)

2.       Use Inside 5 minute/inside 5 cheat or inside 15 minute to get long, ideally in the first half hour after market open

3.       Place stop loss at the low of the day

4.       Raise stop loss as stock is acting correctly on the daily chart

5.       Take profits at key target levels

Rationale: It all starts with the fundamentals and having the right read on the stock’s earnings catalyst. The technicals are the method I use for getting a good risk/reward entry so that I can limit the damage if I am wrong. 

For more on which earning gapper setups I am currently focused on in Q2, consider becoming a premium subscriber to Marlin Capital. 

Thank you for reading!