Earnings announcement day divides traders into two groups – ones who avoid trading during earnings announcement day of the company because of higher volatility and uncertain moves caused by the announcement. The rest of the traders try to make a profit from this market moves. They analyze past earnings reports, company news, or use make their own strategies to trade price drifts caused by earnings.
Earnings reports are released by publicly-traded companies on a quarterly basis in the United States. These reports are often the primary source of evaluation of companies. Therefore, there is expected to be higher price volatility because of revaluating the company by the newest data provided by earnings report. Strategies oriented on trading earnings are focused on the period before the earnings announcement, earnings announcement day or period after the earnings announcement. Thereupon these strategies are short-lasting and are active mainly during earnings season (except some post-earnings strategies which could catch trends that lasts months).
Example of a strategy aimed at pre-earnings period is Pre-Earnings Announcement Drift which bets on people behavior. People like to extrapolate things from the past into the future. Therefore, the over-extrapolation leads to predictability in returns around earnings announcements from their past results. Thereupon previous earnings announcement returns are strongly correlated with the next period’s pre-earnings announcement returns. This strategy goes long companies which meet its criteria in the pre-earnings period, which is defined as five days before the earnings announcement date.
The period after the earnings announcement is characterized by Post-Earnings Announcement Drift effect known in the literature as PEAD. It is a well-documented and one of the most robust anomalies on delayed market reaction to earnings news covered by numerous academic research papers. It has been documented that firms reporting huge positive earnings changes experience positive abnormal returns over the six months after the earnings announcement. In contrast, those that report large negative earnings changes experience negative abnormal returns. Many supplementary strategies could enhance the PEAD effect – accruals, momentum, quality and other factor strategies.
