Thursday, November 27, 2014

Mind the gap!

One of the dangers of trading equities is the potential for price gaps when unexpected news is released. A good example of this week was UK stock Thomas Cook Group.

This had been a turnaround story where I know of a few trend followers who profited massively from the uptrend which started at the end of 2012 and carried on through the first half of 2013. 

As we can see, the stock had started trending in an upwards in recent weeks before a huge price gap occurred on on yesterday's open when it was announced the company's CEO was to leave.

The fact that the price action did not match our own criteria, and therefore is not a position we would have taken is not the point here. The fact is that people using different entry parameters, or maybe who use moving average crossovers, for example, may well have taken the trade.

Dealing with price shocks such as these are an occupational hazard for someone who trades equities, and is another example (if one were needed) to be very cautious in terms of your risk per trade. Depending on your own preferred timeframe and parameters, you may also need to consider a cut-off point where you pass on opening new trades in a stock when earnings are due to be released in the next week or two.

While it is obvious that you can also profit from earnings surprises, I am more concerned with controlling my risk and trying to eliminate the potential for a price gap against me wherever possible, as these trades could easily result in a loss greater than my initial monetary risk. Hence, due to the relative short-term nature of my entry/exit parameters, I avoid opening positions in stocks where earnings are imminent.

Even though this announcement was timed to coincide with the company's latest earnings update, news of this sort and the subsequent price shock can occur at any time - you've been warned!

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