Paul Tudor Jones and Episodic Pivots | stockbee


Paul Tudor Jones and Episodic Pivots

“Anything greater than an 8 percent move in stocks in one day is probably because of something either so fantastic or so bad that taking more than another day to think about it is a good thing,” Paul Tudor Jones, 56, said.

This is a very insightful quote. When stock makes a big one day move it is often telescoping a big story. Such big moves are not everyday happenings. Such big move happens if there is a catalyst. I have an entire method that I trade around this concept of a stock making a big 8% plus move in a day and had significant success using it. Sometimes I have found neglected stocks which made 100 to 400% moves using this simple idea of everyday tracking stocks that make 8% plus moves. The method I trade based on this concept is called Episodic Pivots or EP .

The dictionary defines episode as a significant incident: an event that is a part of but distinct from a greater whole and that often has specific significance.
Episodic Pivots are significant events in the life of a stock. These are incidents where new information becomes available to market participants and as a result there is re evaluation of current trend or price level. Such new information can launch a rally lasting months or years or reverse a pre existing rally. If you look at stocks which have made big moves over their life time you would see a series of episodes triggered those big moves.
How does the market react to new information or "surprise". If market was perfectly efficient once a new information likely to effect stock price is released the stock price should immediately trade to the new level and there should be no way to profit from such surprises. However in real life markets are inefficient. Market participants have many biases and as a result they tend to overreact or underact to new information. People learn slowly. There are not enough quick learners to eliminate mispricing in markets. Investors overreact to negative news and as a result you will find a huge gap down or down move on negative news. Investors become overly optimistic about recent winners and overly pessimistic about recent losers. Under such circumstances if you have a "surprise" on a stock on which investors are overly pessimistic then such information produces a big jump in price creating a Episodic Pivots. As investors are skeptical about such information they under react to such new information. Analyst are slower to factor in that new information in their targets. As investors learn and slowly digest this new information, it results in price momentum as price keeps drifting higher or lower to reflect the new information.
So a ideal bullish EP is a situation where investors are overly pessimistic about a stock or have low expectations and then a new information is released to change that hypothesis. In price term what we are look in for is a stock which is not rallying in to EP. Ideally has a price trending down for last month or so before EP day. Alternatively a stock which has a long sideways move indicating indifference or a neglect. A neglect in stock is also represented by low trading volume and no analyst coverage.
So we are looking for three kinds of preconditions for ideal EP:
  1. A stock trending down for a month or so.
  2. A stock with 3 to 6 month sideways move.
  3. A neglected stock with low trading volume or low analyst interest.
In light of new information such stocks are mis-priced and so a EP results in momentum. Such momentum lasts till next information release cycle. In EP strategy we are primarily interested in a new information that has potential to move a stock 50% plus in a quarter or so.
There are basically two types of EP:
  • Earnings related EP
  • Non earnings related EP

Earnings are the most important criteria affecting stock prices both in short term as well as long term. Investors want to invest in companies that are growing their earnings or are likely to grow their earnings in future. Wall Street is obsessed with earnings and rightfully so. So any earnings related news has a potential to move stocks in either direction. Studies after studies have shown that trading strategies based on post earnings announcement drift (PEAD) has consistently generated abnormal returns.
Ball and Brown in 1968 first documented the PEAD anomaly. As its name suggests, the PEAD is the tendency of stocks that beat earnings expectations to continue to drift upwards for about two months after the announcement, or likewise for stocks that miss earnings to continue to drift downwards. The market does not immediately fully incorporate the information contained in the earnings announcement in to the stock price.
So when a company announces earnings and it is "surprisingly" good or bad it leads to a rally lasting 2 to 3 months. Earnings EP are easiest to understand and act on. The market reaction tells you whether this earnings was :surprise" and "significant". The stock will immediately go up post such announcement and the move will be supported by high volume. The EP scan captures such breakout.
What does the EP scan look for:
( 100 * (C - C1) / C1) >= 8 AND V > 3000 AND (100 * V / AVGV100) >= 300
It basically looks for a out-sized price move of 8% plus A volume surge of 3 times average 100 day volume.

So a stock appearing in EP scan has a volume surge and the price surge. We then investigate what caused this price and volume surge or what was "the surprise" that caused such a big move and what is "the nature" of such surprise. Is this information likely to lead to big move.
For that we look at : - Context of the earnings. Is this a first major earnings acceleration. - What caused this acceleration. Is it one time or likely to persist. - Does this earnings trend represent a structural change in the industry or the position of this company. - Is this surprise reflected in current price level.
Market reaction tells you a lot about the likelihood of future prospect of that stock. If volume is very high, you can assume move has legs. You will see that most EP which go on to make really big like say 100% plus kind of moves in next 1 to2 months post an earnings EP will have huge volume surge, typically of 10 times or more compared to average volume. The volume on EP day might be highest volume in the history of the stock or multi year high volume. So when analysing EP I always sort my list by Volume surge and first look at stocks with highest volume surge.

In earnings EPs there are two kinds of situations:
  • Stock with no analyst coverage
  • Stock with analyst coverage
Stocks with no analyst coverage are typically smaller companies or companies which are out of favor. On such stocks a significant earnings acceleration compared to last year same quarter as well as quarter over quarter is what to look for. I like to look for companies which had earnings acceleration of 100% plus in such cases. Many of the current market leaders at some stage in their price life cycle such companies. They were neglected small companies which market noticed when they announced big earnings acceleration.
Stocks with analyst earnings coverage are widely followed stocks on the street. Such companies in most cases are well established companies. They have predictable earnings most of the time and analyst keep a very close eye on such companies and constantly adjust their earnings target. But once in a while such companies manage to significantly surprise the market and that results in a earnings EP. Earnings EP on companies with significant analyst coverage do not do as well as the first kinds. Genuine analyst surprises are rare and in many cases company pre announce and manage earnings expectations to avoid significant surprise. Established companies also often time secondaries and other capital raising events to time with such surprises and so often you find the EP on such stocks tend to have a pullback.
If a earnings EP happens on low float stock it is ideal situation. This is an ideal combination. In such situation you can have really explosive move. Float below 25 million is ideal for this. The best moves happen on float below 10 million. EP on companies with 100 million plus float tend to have pullbacks. EP's on stock with 500 million plus float is something which I not really very enthusiastic about unless they are trading near their historic lows or are in single digits.

Non Earnings EP are of various types and are often difficult to judge. The most common non earnings EP are:
  1. Top Sector EP: These tend to happen in later or last part of a sector big move. At some stage everyone is very bullish on a sector and in that case almost all stocks start breaking out. Such stocks may or may not have any earnings may be of questionable quality but due to sector momentum they make big moves in few days or weeks. These can be very profitable as long as you can get out of them before they crash. To find these look for Top sector by IBD relative strength or Stocks in Top 11 sectors by MDT.
  2. New Order EP: These are common in industries where there is a big lag between orders and actual sales. Defense, heavy construction, aeronautics, heavy engineering, project management , etc sectors are where such EP work. In this case news of a large order or a series of orders can trigger a big move in such stocks. In such cases the current financials of company does not matter.
  3. Buyout Rumor: I stay out of these kinds of EP.
  4. Regulatory Changes: Change in govt policy can often cause EP. Recent example of this is the solar sector where the news of proposal for providing subsidy by Chinese govt for solar installation lead to EP on all Chinese solar stocks. In such cases again the current earnings or financials do not matter.
  5. Drug Approval EP: FDA approval news leads to EP on biotech sectors. These can be very volatile EP and often can make unimaginable moves. Stocks will double, triple or go up 10 times on more news of FDA approval. Such EP are typically on developmental stage companies and many of them trade on such news. Such EP can also crash quickly so one has to be very careful on these and not tale very large positions. Many of these EP's sometime will have gap ups of 50% plus and still go on to make big moves. In such EP I look for EP with over 10 times average volume. Less than that don't tend to work too well. In most good biotech EP the volume surge in first 30 minutes of trading or in pre market itself will be over 4 to 5 times average 100 day volume.
  6. Drug Marketing Tie up: In this a small developmental drug company ties up with a large pharma company for joint marketing of the drug. In such case the large company makes a upfront payment for rights to such deal. Typically deals involving 250 million plus upfront payments tend to produce good EP. Again in this case EP with 10 times average volume surge tend to work better.
  7. Natural disaster/ war/ disease: Often such events produce EP's in companies likely to benefit from such event. Lot of time this is just speculation that these companies will benefit from such event. e.g. when the stock market opened after 9/11 the companies which produce bomb detection equipment for airlines had EP. One of them InVision had a EP with about 10 times volume surge. The symbol was INVN , I think. It went on to make 450% move over three month or so and was ultimately acquired by GE.
  8. Shortages: These kind of EP happen in commodities related stocks. News of shortages, drought or crop destruction can often lead to EP. e.g. in the beginning of 2008 there was news of coal shortage in China. This resulted in EP in all coal related stocks in our market and some of them made very big moves.
  9. Rate Increase: Again these are common in commodity type stocks or in other industries where profitability is greatly dependent on slight price changes. Shipping industry is one where the Baltic Dry Index drives these stocks behavior and any sharp increase in freight rates lead to big moves in stocks.
  10. Media Stories: Barron's, Business Week, Forbes, James Crammer , etc can often create EP. Such EP tends to have very low success rates.
This is what happened to OPEN post that Episodic Pivot...

On the members site there is extensive discussion on this method and sometime back I did an entire bootcamp on this topic. I have been trading this method for around 10 years.  

Moral of the story pay very close attention to a stock that makes 8% plus move on a big volume. Listen to Paul Tudor Jones.

Related Post
Paul Tudor Jones and Episodic Pivots Part2



badar_basim said...

hello what book or series of books influenced your creation of market monitor?


badar_basim said...

hello what book or series of books influenced your creation of market monitor?


Pradeep Bonde said...

Being Right or Making Money. Ned Davis

Martin Zweig's Winning on Wall Street

badar_basim said...

i think i am missing the market breadth component in my trading. i have been trying to sign up for ur stockbee services but the paypal page doesnt load no matter how hard i try. i even tried a proxy.


is there another way to sign up

Pradeep Bonde said...

Send me an email at esyguru@gmail

badar_basim said...

follow up question,

so whatever you have learned in those two books, you wrote it down in the members part of the site?

or do i still have to buy those two books.

Pradeep Bonde said...

I just got an idea from the book rest all I developed on my own. Those two books are not necessary to understand market breadth.

jeff said...


Have you read Stan Weinstein's Secrets for profiting in Bull and Bear Markets? If so, can you share your thoughts.


Pradeep Bonde said...

It is a pretty basic book which basically talks about four stages of stocks life cycle. He hypothesizes that most stocks experience four price stages:accumulation stage, uptrend stage , topping stage, and down trending stage. And says to focus on stocks when they are about to enter up trending stage. He uses if I remember correctly 30 week MA to define the stages.

That is one way to skin the cat, there are in my opinion other better ways to skin the cat.

Overall a pretty basic TA book. The same thing Wyckoff wrote many years ago in his books.

Besides that Stan had difficult Time making money with his method and closed down his once very popular newsletter in 2008 and it was ranked pretty low in returns.

John Yoga said...

I am not understanding Paul's English. It would seem to me that he meant to say " a bad thing." In other words, you don't want to wait additional days to get into a large gapper.

I also trade these, especially when there is a large (>5% move on an otherwise quiet stock) to the downside. I do Call Credit Spreads.


Pradeep Bonde said...

It is good