Becoming a successful trader is difficult in any market, but this is especially true during times of heightened uncertainty.
In such times there is little margin for error. As the upside potential shrinks, the prospect of jarring downward corrections expands.
When such corrections happen, emotion begins to drive decision-making for many investors. According to professional trader Matt Choi, this is when traders need to refocus on the basics — macro economic trends plus the financial health of individual companies as reflected in earnings reports.
Choi is the founder of Toronto-based Certus Trading, which provides a range of educational courses on how to trade stocks, ETFs, options, commodity and financial futures, and FOREX.
“We teach trading in a simple and practical way that achieves results,” he explains. “It’s not about abstract economic theories, complex algorithms, or hindsight analysis. We focus on real-time trading ideas that empower the individual investor to trade in all market conditions with accuracy, confidence and without hesitation.”
In recent months, hope, fear, greed and a herd mentality have taken turns as primary drivers of markets, notes Choi, who contends that the two best antidotes to fear in financial markets are asset allocation and long-term thinking. The latter is often referred to as a “time horizon.” In financial terms your time horizon is dependent on how soon you may need to draw down your assets for retirement, college, the purchase of a house or other events.
Your time horizon is greatly influenced by your risk tolerance. Your level of aversion to risk will classify you as an aggressive investor (whose priority is “capital growth”), a conservative one (priority: “capital preservation”), or an investor somewhere in between who seeks a balance between liquidity and rapid growth.
Meanwhile, as you remain faithful to your time horizon, proper asset allocation will also help insulate you from the most severe financial shocks, Choi adds.
Keep an Eye on Corporate Earnings
One way to make prudent investment decisions amid an uncertain market is to keep an eye on corporate earnings. Corporate earnings are the key to a stock’s value over the long-term.
Companies are well aware that their earnings reports will have a dramatic impact on analysts’ opinions, and ultimately the share price. Not surprisingly, they hope to bury bad news and trumpet every hopeful sign.
When Certus Trading reviews the current market, volatility is the watchword for the foreseeable future. This volatility in financial markets adds to the complexity of predicting the way forward for companies and the overall economy. Many recent earnings reports confirm a slowing of economic activity in North America. And some major companies have also begun to announce layoffs.
In this environment, companies are well aware that a negative earnings report can be the first domino in a succession of unwanted events: First the share price falls, available capital shrinks, production slows, workers are laid off, and investors become increasingly bearish about the company’s prospects for profit.
Knowing this, companies are typically careful to manage expectations, which influences the ways they report earnings. The goal is to lower expectations so that financial analysts will be pleasantly surprised when earnings exceed this arbitrary threshold.
What this means for an investor is that although earnings season produces a flood of data, it takes time and patience to clear through the accounting spin to determine the true health of a company, and the status of your investment. Adding to the difficulty of this task, corporate earnings can be packaged in several different ways:
When a company reports pro-forma earnings, it is providing an alternative to the Generally Accepted Accounting Practices method of calculating earnings. A company might do this to exclude non-recurring expenses such as restructuring costs, interest payments, taxes and one-time events.
Forward earnings are forecasts of future profit. As with pro-forma earnings, there are many different ways that companies calculate the figures. Forward earnings are an important gauge in estimating the future value of a stock, but these forecasts aren’t always realistic.
Trailing earnings provide hard data about company performance. This type of report details the profit during a 12-month period, which may be the past fiscal year or a 12-month period calculated on a rolling basis. Trailing earnings are used to calculate earnings per share (EPS) and the price-to-earnings (P/E) ratio. Both these figures are closely watched by analysts.
Reading quarterly earnings reports is a complex task, because many reports are focused on burnishing company performance, managing expectations or directing attention away from unpleasant events. When Certus Trading reviews recent quarter earnings reports, the data point to volatility and uncertainty ahead.
In this environment, the best investment strategy is to remain focused on your personal financial goals, guided by your risk tolerance and amount of time you anticipate holding a company’s shares. Prudent asset allocation and long-term perspectives are the best strategies for finding safe harbors and navigating steadily closer to your financial goals, Choi adds.