Short interest can also play a role on stock movement
When combined with fundamental and technical factors (a 3-tiered methodology we call Expectational Analysis®), sentiment becomes a powerful tool for analyzing stocks, sectors, or the overall market. This is especially important as earnings season ramps up.
A quarterly earnings report details a company's finances by breaking down revenue, profits, costs, and other important financial metrics for shareholders and analysts. Earnings reports also often provide a full-year fiscal outlook, as well as anticipated risk factors for the firm or sector in general, providing a glimpse into a company's strengths and weaknesses -- a fundamental report card, so to speak. However, contrarians know that pre-earnings sentiment -- or expectations -- can affect the post-earnings behavior of a stock.
Generally, when earnings beat analyst expectations, the stock will swing upward, while weaker-than-expected top- or bottom-line figures will often lead to losses on the charts. So, even if a company reports 100% year-over-year (YoY) earnings growth, the underlying stock could still drop if expectations were for a 200% YoY profit. On the flip side, if a company says revenue fell 50% from the previous quarter, the underlying stock could still rise in the face of very low expectations.
For example, if analysts are very bearish on a stock ahead of earnings, and the company posts a surprise quarterly profit, a slew of subsequent upgrades could add fuel to the shares' post-earnings fire. On the other hand, if analysts are extremely "buy"-heavy ahead of earnings, a surprise per-share earnings loss or lackluster guidance could trigger downgrades, exacerbating selling pressure.
Short interest can also play a role. If a firm reports stronger-than-expected earnings, or issues surprisingly upbeat guidance, shorts could get squeezed as the underloved stock muscles higher. A short-covering rally could ensue, as bears rush the exits.
Likewise, if option buyers are more put-heavy than usual ahead of earnings, a positive earnings surprise could lead to the unwinding of these bearish bets, pushing the stock higher. On the flip side, an earnings miss could fuel an exodus of option bulls.