By: Spencer Israel
The first earnings season of 2020 is upon us, which means the market is gearing up for the first real period of sustained volatility in stocks of the year (war with Iran notwithstanding).
Earnings season presents a great opportunity to utilize a sympathy trading strategy. That is, a strategy that involves trading stocks that are moving “in sympathy” with another related stock. Because a stock’s earnings reactions can be nearly instantaneous in the premarket and after-hours sessions, sympathy trading is a good way to trade earnings without having to compete against algorithms that can decipher press releases in seconds.
On its surface, sympathy trading is relatively simple to understand. It’s all about knowing relationships and which stocks trade together. The most obvious example of these relationships are companies in the same sector or industry. If three bank stocks report earnings on the same day (as JP Morgan, Citigroup, and Wells Fargo did the morning of Jan. 14), expect other big bank stocks to trade up or down in sympathy (like Morgan Stanley, Goldman Sachs, and Bank of America did). Likewise, retail stocks trade with other retail stocks. Tech stocks with tech stocks. Cannabis with cannabis. And so on.
But outside of those obvious examples, there are other relationships that can create sympathy trading opportunities. One of the most well-known is Apple and its suppliers. Apple products are so ubiquitous, that companies on their supply chain (such as Samsung, Micron, Jabil, and Lumentum, to name a few) can react to Apple-specific headlines. Keep an eye on those names when Apple reports on Jan. 28 after the close.
Another go-to relationship to mine for sympathy ideas is geographical. The best example of this is China. It’s not unusual for Chinese stocks (such as Alibaba, Baidu, JD.com, and Weibo) to trade together when one company has news.
Here are a couple of potential sympathy trade ideas for the coming weeks.
Sympathy Idea 1: Sympathy Earnings Reactions
The morning of Jan. 31 will be a big one for energy. The two largest energy stocks in the U.S., Exxon Mobil and Chevron, will report Q4 earnings that morning (Phillips 66, the sixth-largest energy name by market cap will also report).
How those earnings reports compare to Wall Street’s estimates will go a long way in determining the market’s sentiment towards energy stocks that morning. Keep an eye on the sector as a whole, specifically energy companies due to report in February such as ConocoPhillips and EOG Resources.
Sympathy Idea 2: Trading ETFs against stocks
Another way to capture sympathy moves is to trade ETFs against stocks they hold. The previous example of Exxon Mobil and Chevron is a good one here because they are the two largest holdings in some of the largest and most liquid energy ETFs.
Collectively, the two stocks make up approximately 42% of the Energy Select Sector SPDR ETF (XLE) and the iShares U.S. Energy ETF (IYE), and 39% of the Vanguard Energy ETF (VDE). All of these funds, by nature of their construction, will have to reflect any earnings reaction seen in shares of Exxon Mobile and Chevron.
There are many more examples of relationships across the market that can make for good sympathy trades. Banks stocks are inversely correlated to bonds. Companies that are merging will trade together until the merger closes. Stocks in the Dow Jones Industrial Average generally trade together.
When it comes to knowing these relationships, it’s partly a matter of following the news, knowing fundamental information, and putting in the screen time to observe these relationships for yourself.
The author is long all of the stocks mentioned in his 401(k).
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