Investors face several kinds of risk in the stock market. Today we’ll consider one of the most common: event risk.
While some events are unexpected, many are known. Stocks often move around certain occurrences, like earnings reports, Federal Reserve meetings or economic reports. Events can be difficult because stocks may drift aimlessly for weeks or months without clear signals. Then a big rally or selloff takes place in a single day around a piece of news.
We’ll first examine different types of event risk, then look at how investors can manage it.
Event Risk in the Stock Market
Event risk results from a single item having an outsized importance. For example, most companies’ finances revolve around quarterly results. Fed meetings or non-farm payroll reports have big significance for interest rates and the economy. Those, in turn, have major implications for profits and spending. Therefore it makes sense that investors hold their breaths for these big catalysts.
It can play out in a few typical ways. First, investors might expect good or bad news on a certain date. Prices could move in the direction of the news before the headline hits. The risk is then a reversal after the event. This is often explained with the saying “buy the rumor, sell the news.”
For example, a company with a history of beating profit estimates could be scheduled to announce results on a certain date. The stock may rally before the report, only to drop after its numbers are public. In this case, the event caused both a rally before the news and a selloff after. The exact same thing can happen to the downside, with stocks falling in anticipation of bad news and then jumping afterwards.
Second, events are not always what you might think. Bottom-line earnings might be strong, but results in a certain key product might be weak. Guidance might disappoint, or surprise to the upside. Or, investors might be focused on entirely different items like a spinoff. This is why it’s also useful to know the seven catalysts for stock movement, outlined previously on Market Insights.
Third you have the liquidity surge. Because the market waits for key events, they often trigger more activity. The resulting volume spike makes it easier for institutions to to buy or sell large positions. That expectation for increased liquidity — with everyone waiting and then acting all at once — is another ingredient in event risk.
Types of Event Risk
As mentioned above, quarterly results are probably the most common type of event risk. These are easy to anticipate because companies almost always indicate the time and date. They also tend to occur around the same parts of each quarter: major financials usually report first, followed by big technology stocks and then retailers. You can also track earnings dates on TradeStation’s web and desktop platforms.
Fed meetings, which are also announced months in advance, can also have a big impact. Central bankers issue a policy statement after each meeting at 2 p.m. ET. A press conference sometimes follows. Officials can also make speeches and testify before Congress. Most of these events are also announced with several days of notice.
Various types of economic data can also impact the market. For example, the Energy Department announces crude-oil inventories at 10:30 a.m. on Wednesdays. OPEC also holds occasion meetings. These events can have bullish or bearish effects on energy prices and energy companies. Homebuilders also have events like housing starts and building permits. Watching economic calendars can prepare traders for these events.
Elections or product announcements can also be risks. Investors might want to put money to work, but simply wait for the event to pass before acting. Impatient traders may find themselves entering prematurely, getting stopped out and then missing a rally. Focusing on the event can help overcome this challenge.
Managing Event Risk
The main takeaway for investors is to understand that events can have a big impact on their portfolios. It’s impossible to predict how any individual scenario will play out, but there are some common patterns.
For example there could be a “buy the rumor, sell the news” event. If a stock rallies into a quarterly report, traders may sell some shares or write calls beforehand to reduce the risk of a post-earnings drop. Alternately, if investors want to own a stock that’s been falling, they might wait for the potentially bearish event to pass before buying.
Vertical spreads are another technique for managing event risk. Traders looking for stocks to rally after earnings may purchase a call spread, while bears can own a put spread. Investors looking to hold long positions can also use put spreads to hedge.
Finally some events in the market are totally unpredictable, like product recalls or mergers. Unlike known events, these hazards cannot be directly managed. However investors can offset them with diversification and by understanding sector risk. (That’s when one of your holdings is hurt by weakness among its peers.)
In conclusion, event risk is an underappreciated aspect of investing in the stock market. Single occurrences can have abnormally large impacts on prices. Understanding these patterns is the first step to managing event risk. While exact reactions or directions cannot be predicted, prices often follow certain paths that can be understood and managed with the steps highlighted above.
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