Inside information about earnings won’t guarantee winning trades: Morning Brief

Sam Ro

·Contributor

Updated Fri, Jan 24, 2020, 3:07 AM

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Friday, January 24, 2020

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Even when you think you know, you still don’t know

Netflix (NFLX) shares initially jumped on Tuesday evening during post-market trading immediately after the company’s Q4 financial results were released. People attributed the move to better-than-expected earnings and subscriber growth.

But minutes later, shares fell. People attributed the move to disappointing guidance.

The stock ended up falling 3.6% during Wednesday’s trading session, the first full day after Netflix’s quarterly report.

And then on Thursday, shares jumped 7.2% for a whole new set of reasons.

There’s a ton of stuff to be said about all of this. But one thing we will say is that having the Netflix earnings announcement before everyone else wouldn’t have really helped you make a winning trade.

In fact, Ph.D. candidate Chloe Xie at Stanford explored this in a working paper titled: “The Signal Quality of Earnings Announcements: Evidence from an Informed Trading Cartel.“ (via DataTrek Research)

Xie analyzed the performance of a “cartel of sophisticated traders” that made trades based off of more than one thousand illegally obtained earnings announcements.

“Despite earning large profits overall, the informed traders enjoyed only mixed success in identifying the biggest profit opportunities,“ Xie said. “About 70% of their informed trades missed the biggest stock price return opportunities.”

Wall Street's Bud Fox trades on insider information. (IMDB / 20th Century Fox) — Fictional broker Bud Fox traded on insider information in "Wall Street." Could he beat the market today? (IMDB / 20th Century Fox)

To be clear, these crooks made a fortune. But they were far from batting a thousand.

“[The study shows] that earnings releases are ‘noisy’ – replete with information that markets will take as good or bad in unpredictable fashion,” Nicholas Colas, co-founder of DataTrek Research said in a December note. “On top of that, markets go into earnings releases with a hard-to-determine set of expectations. Combine the two issues, and you have the explanation for why just seeing the earnings release is not a foolproof path to 100%-certain trading profits.“

In other words, the same earnings announcement can be seen as good or bad depending on who you ask.

And further, traders and investors go into these announcements positioned with a wide array of expectations that are far from homogenous.

Investing for the long-run is hard enough. Trading in the short-term is even harder.

Even when you have inside information.

By Sam Ro, managing editor. Follow him at @SamRo

What to watch today

Economy

9:45 a.m. ET: Markit US Services PMI, January preliminary (52.5 expected, 52.8 prior)
9:45 a.m. ET: Markit US Composite PMI, January preliminary (52.7 prior)
9:45 a.m. ET: Markit US Manufacturing PMI, January preliminary (52.5 expected, 52.4 prior)

Earnings

Pre-market