On a regular basis, a company will announce a quarterly earnings number that is less than the analysts expected. This usually causes a large drop in the share price the following day.
So how do you protect yourself from these sudden drops?
- You should know the date of the quarterly updates for your major holdings. If you see the stock moving up for a few days before the announcement, you may want to take some of your earnings off the table and lock in your profits. You can always jump back into the stock if the price continues to move up. The opposite of this is also true, if you start to see the stock price drop for several days before a quarterly announcement, assume that insiders are getting out early and join them in leaving the company.
- You should setup your account to automatically get you out of a stock if it has a major price move. This should be standard practice for all of your holdings as it will protect you in the event that news breaks that adversely affects your holding or the market in general. Your broker should have a way of allowing you to do a conditional trade. A conditional trade should be set up like this: Sell 100 shares of XXXX as a market order if the price of XXXX drops over 7% in a single day. This order is different than a trailing loss order as it is only looking for a rapid drop in a single day rather than just a gradual decline over the course of time. You could have a trailing loss order of 10% but the conditional order will get you out faster if the stock is moving very rapidly due to bad news.
- If you are watching the quarterly announcement of your holding, you can easily check what the after hours trading is doing based on the news. If you see the stock has dropped, then you can let your conditional order save you. If you think the reaction is incorrect and you want to weather the short-term loss, you can log into your account in the evening, cancel your conditional order, and then replace the conditional order at about noon the following day after the market has stabilized. Most bad news will change the stock price in the first hour or two of trading if it is just going to be a quick correction. If the price is still rapidly dropping at noon then you may want to exit the stock as well, as the news is probably worse than you thought.