The idea
When a company's results beat expectations by a wide margin, its stock usually jumps. Decades ago researchers noticed it also tended to keep drifting in the same direction for weeks afterwards, as if the market were slow to absorb the news.
The strategy buys stocks after large positive surprises (and sells short after large negative ones) the day after the announcement, and holds for about three months.
Watch it play out
Step by step
The rules
Setup
- Results with a large surprise against expectations (by earnings or by the price reaction).
Entry
- Buy at the close of the day after the announcement.
Stop-loss
- A wide stop under the earnings-day low, or none, with small position sizes.
Target
- Hold for about 60 trading days, then sell.
Filters that help
- Spread it over many stocks: single cases vary widely.
- Smaller, less-followed stocks showed the effect more strongly, with higher costs.
Why it can work
Investors underreacted to earnings news: analysts revised slowly, funds adjusted gradually, and the full meaning of a surprise took time to price in. Buying after the first reaction captured the rest of the adjustment.
Over time, more investors and computer programs began trading the surprise on the day itself, and the gap left for the slow adjustment shrank. That is the usual life story of a published edge: once well known, it gets traded away.
Worked example
A company beats expectations and its stock gaps from $60.60 to $63.60. You buy at the next day's close at $64.50 and hold.
Over the following weeks it drifts to $68.60 and you sell after about 60 days: in this example 6.4% after the entry. In practice many single cases go the other way; the effect was an average over many stocks.
When it works, when it fails
Works best
Historically in smaller, less followed stocks with large surprises, held across a diversified basket.
Struggles
In large, heavily followed stocks today, where prices absorb surprises almost immediately. Single positions are noisy, and costs eat a small drift.
Common mistakes
- Buying in the opening rush on results day instead of the day after.
- Relying on one or two stocks.
- Expecting the strong results of 1980s studies today.
Variations
- Drift after a price reaction
- Using the size of the results-day move, rather than reported earnings against forecasts, to pick the stocks, which is simpler and close to how traders apply it.
- Earnings revision momentum
- Buying stocks whose analyst forecasts are rising after results, a related signal.
What the evidence says
Evidence: ResearchedPublished studies exist. Results depend on the details and on costs.
Post-earnings announcement drift is one of the most documented patterns in finance: a classic 1989 study found strong drift for about 60 trading days after surprises, positive in most quarters from 1974 to 1985.
A 2021 study argued the drift has disappeared for large US stocks since about 2006 and only recently for microcaps. Hence researched, with evidence that the edge has largely faded.
Questions
- How is an earnings surprise measured?
- Research usually compares reported earnings with analysts' consensus forecast, or with the same quarter a year earlier. Some traders simply use the size of the price reaction on results day.
- Does the drift work for negative surprises?
- The classic studies found it in both directions: stocks with bad surprises kept drifting down. Shorting them adds borrowing costs and rules to check.
- Is PEAD the same as gap and go?
- Both start from news, but gap and go is a day trade on the first hours, while PEAD holds for weeks to capture slow adjustment.
- What is post-earnings announcement drift?
- The tendency of stocks to keep moving in the direction of an earnings surprise for weeks after the announcement.
- Does PEAD still work?
- Research suggests it has largely disappeared in large US stocks since the mid-2000s and weakened in small ones. It may survive in less efficient markets, after costs or not.
- How long is the drift?
- The classic studies measured about 60 trading days, roughly three months.