PM: AAPL plunges after-hours

PM Update

The S&P50o notched another new high, but the big headline is AAPL’s poor performance in after-hours trade following its earnings release.  The company announced record earnings, but the market was unimpressed and pummeled the stock.  It is okay to be wrong in the markets, but it is fatal to stay wrong.  Anyone caught on the wrong side of this trade needs to follow their trading plan.

MARKET BEHAVIOR

The S&P500 traded fractionally higher, but it was enough to set another new high.  Today’s volume was above average, but the lowest out of the last four days.  Good earnings from blue-chip companies propped up the tech sector, at least during regular hours.  Of course everyone knows what happened after-hours, but we will get to that later.

MARKET SENTIMENT

The market keeps pushing higher, but in a tentative way.   We see early weakness followed by a rebound and modest gains.  1500 is just a few points away and the rally lacks the enthusiasm and conviction to make a strong move higher, but this is not a bad thing.  Caution is a common characteristic of sustainable rallies.  Brashness, overconfidence, and complacency are hallmarks of major tops.  Reluctance to over-commit here means many traders are still holding back and their available reserves are the fuel that can continue pushing this market higher if they are compelled to chase a move higher.

But enough about this stuff, everyone wants to hear about AAPL.  AAPL is the largest member of the S&P500 and NASDAQ indexes.  No doubt today’s after-hours selloff will be felt by the indexes tomorrow and could be a catalyst for a near-term market top.  AAPL closed lower by 10% at the end of after-hours trading and is primarily responsible for a 0.4% drop in SPY and 1.5% in loss in QQQ in after-hours.  AAPL has largely been a single-stock story recently as it traded near 52-week lows while the S&P500 was making 5-year highs, but is this story big enough to shift market sentiment and finally trigger pullback?  It will be interesting to watch.

TRADING OPPORTUNITIES

Expected Outcome:
Tomorrow will be a real test for the market.  If the pattern of strong closes continues, it is showing signs the market wants to keep going higher.  But if the market cannot shake early weakness, look for bears and nervous holders to pile on the selling and push the marked back down to 1470.

INDIVIDUAL STOCKS

Swing and a miss.  Obviously I blew my AAPL call.  Not that it was a bad trade, it just didn’t work out and that is all that matters.  AAPL had one of the most profitable quarters in the history of the word, yet the stock was pummeled 10% after-hours.  We don’t trade fundamentals, we trade stocks and when the stock goes the wrong way we lose money.  Simple as that.

For those of us in AAPL, we need to figure out how to pick up the pieces.  It is perfectly normal, even expected to be wrong in the markets, but what is fatal is staying wrong.  Successful traders take their lumps and move on and that is what we need to do here.

In Wednesday morning’s post I wrote about position size.  Using a 3% risk target and the option market’s expected move of 7%, I came up with a maximum position size of $43k for a $100k account.  Lets see how this trade did if the after-hours selloff holds into Thursday.

At the height of selling, AAPL was down 11% from Wednesday’s close, so lets use that number.  An 11% loss was larger than the option market’s prediction of 7% and 11% of $43k is a $4,730 loss, or a 4.73% hit to the $100k model portfolio.  While an ugly number, it certainly is not a catastrophic loss and easily lets the trader live to fight another day.  The original 3% loss limit was conservative to begin with because as we just saw, sometimes things can get carried away.

But from a risk management perspective, a 5% loss is not that big of a deal.  We took a calculated risk and sometimes these things don’t work out.  But this isn’t just rationalization, a 5% loss is very manageable if we don’t let it grow.  It takes 14-consecutive 5% losses to lose 50% of a portfolio’s value.  (it is not 10 because the losses get smaller as the portfolio shrinks)  But f we let this loss get away from us, it only takes six 10% losses to wipe out half of a portfolio.  This is why cutting losses early is such an important part of success in the markets.

If any of you are in AAPL, don’t feel bad, it was a calculate risk and it didn’t work out.  These things happen and if you are having a difficult time with this, trading might not be the right thing for you.  But no matter what, we need to figure out how to move on.  After-hours trading sessions are notoriously illiquid and the price action we saw this evening might not represent what happens tomorrow.  The after-hours crowd most likely got the direction right so don’t expect AAPL to rally tomorrow, but the size of the loss can be distorted by the thin trade.

Obviously the market will open weak, but where it goes from there is key.  No doubt many traders saw the horrible headlines screaming 10% loss in AAPL and the market will open with a wave of sell orders.  But where the market goes from there will set the tone for the rest fo the day.  One strategy for trading gap downs is to let the market stabilize in the first five-minutes of trade.  If supply dries up after the initial wave of selling, prices can actually rebound through the day.  Take the low of the first five-minutes of trade and use that as your stop-loss.  Continue holding as long as the market stays above this level and if you are lucky you will recover a decent chunk of the early selloff.  But if the market starts selling and breaks the stop-loss, get out!  The first loss is often the best loss.  Take your 5% loss and move on to the next trade.

Tomorrow’s AM post will get more into how to trade AAPL going forward.

Stay safe