The Earnings Gap Up Setup | Stock of the Week (Enphase Energy)

Hey everyone!

This week I am highlighting Enphase Energy (Ticker Symbol ENPH) as my Stock of the Week. ENPH presented an Earnings Gap Up on Wednesday 10/27/21.

This article will analyze the stock through both fundamental and technical lenses and also go in-depth into how you could have traded this name. As always, your main takeaways from these articles should be about the process. The same setups appear again and again due to market structure.

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Routines

ENPH was on my focus list because of the recent strength in solar names and the technical setup in ENPH. Looking at Earnings Whispers I knew that ENPH was reporting after the bell Tuesday and had the potential to present a PEG (Power Earnings Gap). I did not trade this name but it’s always good to analyze strong opportunities you miss

This is what ENPH looked like on the weekend when I put it on my focus list. I liked the strong prior uptrend, long consolidation, and the potential beginning of the right side of the base.

The Fundamentals

ENPH is one of the leaders in the Solar group which is currently ranked #13 out of 197.

Here is a screenshot of the MarketSmith chart of ENPH:

What I really like about the ENPH fundamentals is one, the strong Annual EPS estimates this year, and two, how we are seeing significant expected follow-through next year. The quarterly numbers are also extremely significant and there has been a steady increase in the number of funds quarter after quarter.

Not shown in this chart is the standout ROE of 50%. This, along with strong margins also suggest a very well-run business.

The Setup

Earnings Gap Ups from proper consolidations often indicate the beginning of a strong uptrend and are created when the street is caught off guard. The gap is caused by large orders from institutions. Due to the desired position sizes of these funds, they can not build an investment all in one day. Instead, they must slowly accumulate on weakness and on any pullbacks after the gap up. This creates the strong uptrend which we can trade as retail investors.

An Earnings Gap Up presents multiple opportunities to get in as a trader (depending on your personality).

First, if a stock reports earnings and offers surprises in the numbers, guidance, or new developments, it will usually make a move in after-hours.

For very aggressive traders, there is often a chance to start building a position in after-hours as a stock breaks through resistance levels. This entry point is not for everyone and should only be used by very experienced traders who have traded earnings gaps up for years.

The opportunity really begins the next day. Gap ups are volatile events. Some pull back hard then rally, others sell off the whole day, and of course, there are the Gap and Gos. Be aware of how earnings have been received recently by the market. If the majority of reports (even with good results) have been sold into, then the probability of the next one working is a bit lower. And again, I vastly prefer trading the first or second gap ups in a stock’s run than the third or fourth.

In the morning, you want to see overwhelming volume suggesting that institutions are buying. I look for at least 500% Volume Buzz and ideally, especially early, I want to see volume run rates of 1000% to 5000% above normal. 

A good technique is to watch for strength in the first 5-minute candle and enter when the stock breaks through that candle’s high (or through the 5-minute Opening Range Breakout). As with any trade, you want to manage risk using a stop loss. Quicker traders can set it at the bottom of intraday ranges.

In this particular case, you would have had quite a wide stop loss using the low of the day as a stop (around 6% loss). However, if you entered on the upside reversal bar on the 3rd 5-minute candle and set the stop at that low, you could have managed risk under 3% (See the 5-minute chart below. You also could have moved up your stop to breakeven as the ORB initially worked and then gotten stopped even after it reversed.

Intraday trading is difficult, and manage risk tightly. I’ve highlighted a few potential buy areas - the VCP breakout seems the most proper. Setting a stop at that low would have been a risk of 1% and given you a ~6% cushion going into the next day.

Another way to manage risk and buy on Earnings Gap Up days is to buy slowly, starting with only some of your final desired position, around 30%. If the stock remains strong throughout the day, you can continue to build your position as the market proves you correct. You could use intraday setups to add or just simply add every time the stock increases 1-2%.

The third opportunity to enter occurs the day after the gap up. You can use the HVC method and buy as the stock rallies through the high volume close from the Earnings Gap Up Day (Scot1and also calls this a fishhook).

Using the fishhook would get you at a 7% profit by the end of the week with a risk of less than 2.5% (using the LOD as your stop). This is a great method that allows you to scan for high volume gaps up the night before and prepare for potential entries the next day. You can also use lower timeframes for execution around the HVC level.

Even if you miss any of the aforementioned opportunities, Power Earnings Gaps often present great entries further down the line during the first pullback.

In 2019, TSLA presented many opportunities as it pulled back on lower volume before really taking off.

This setup was also prime because of the long consolidation before the earnings gap up and the two days of highest volume ever in the stock. I prefer focusing on the first gap up in a run. The more gaps up, the further along the stock is within the uptrend. I usually focus on the first two. After that institutions have likely already built positions and the stock is more obvious and additional gaps may be sold into.

Key Takeaways:

ENPH is just one of many examples of Earnings Gap Ups. When these occur after long consolidations in stocks with strong fundamentals, they can potentially be the beginning of a strong trend as institutions build positions. There are many ways to position in an EGU/PEG depending on your style. The most important thing is to always manage risk.

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Have a great weekend!

Richard