A stock upgrade is a fundamental shift of stock by a broker or an analyst from the sell position to hold (neutral) or a buy (bullish) due to increased optimism about its profitability. At first glance, this upgrade in a trading chart causes the stock to break out in the upward direction, indicating that it begins a bullish continuation first in the short-term. It may extend to the long-run if the upgrade is consistent over time. The opposite of this is a stock downgrade, and it is denoted by an influential analyst’s shift from the hold or buy to sell of stock.

Analysts use various indicators to support their upgrades. They include an extrapolation to quarter or annual earnings, price of raw materials, the demand of products, and marginal analysis that show a future boost in profitability. Essentially, the focus is on the market and industry in which the company plays. Upgrades are important calls for investors.

Identification

In February 2021, an investment research firm – CFRA upgraded the Archer Daniels Midland Co. (ADM) stock to a buy rating with a target price of $61. As of March 17, 2021- ADM’s stock price was $57.70. The stock has surged 16.52% from January 21, 2021, through March 2021.

ADM Stock Chart
ADM Stock Chart

The chart shows the price movement has been upwards into February 2021, with investors rushing to buy the stock as opposed to those selling. So, what should investors consider when looking out for stock upgrades?

1. Announcements

Popular and influential investment research firms such as CFRA, Zach’s, or Bloomberg, among others, may announce their stock upgrade news based on research and market analysis. This news essentially changes the rating of the stock. The company may recommend the stock or put it on its priority/focus list.

2. Change of Price range

Investors will be keen on the price range after the stock upgrade has been announced. The change can either be on an intraday basis, weekly or monthly. However, the intraday jump gives the correct impact of the stock upgrade as it shows direct investor momentum immediately.

Intraday Analysis of ADM
Intraday Analysis of ADM

On February 1, 2021 – ADM stock jumped 1.68% after CFRA announced the stock upgrade. The stock began at a low of 49.91 but traded at a high of $50.75 by close of trade. This low-to-high range is above the January 2021 monthly average of 51.46.

3. Breakout

As noted earlier, a stock upgrade is mostly indicated by an upward breakout. The price broke out past the intraday high. The confirmation price is slightly above $50.75, following a decrease from the intraday high. The increase continued past the intraday trading until it reached a high of 57.70 on March 17, 2021.

In this upward breakout, prices will continue to rise for 1 to 3 weeks before they begin to tumble.

ADM Charts- From February 8-to-February 24, 2021
ADM Charts- From February 8-to-February 24, 2021

In our ADM chart, prices continue to soar until February 24, 2021, when they tumble and search for a new support line. The volume also changes in the date of the announcement in line with the shift in prices. However, the news itself may not have as much of a significant effect on the stock price as opposed to the rumor that there may be an upgrade. The investor needs to consider the fundamental analysis of the stock to ensure it matches up with the market expectations.

For example, the stock upgrade for Archer-Daniels-Midland Co. (ADM) was guided by an analysis of the Q4 2020 earnings. ADM’s earnings per share (EPS) in the quarter was $1.21, beating estimates by $0.12. The company’s revenue was $17.98 billion – an increase of 10.10% year-on-year (Y/Y). The revenue beat analysts’ estimates by $1.50 billion.

Operating profit (adjustment segment) also jumped 12% YoY to $1.15 billion as compared to Q4 2019. Other fundamental details such as growth are crucial. Finally, investors will also want to know about dividends. In the case of ADM, the company announced an increase in the quarterly dividend to $0.37 every quarter. This portion represented an increase of 2.8%, which is attractive to many investors. However, as noted earlier, a stock can break out downwards if the announcement is not supported by fundamental shifts of the stock towards the upside. This information will be crucial while executing a trade.

Trading strategy

As an investor, you may be aware of the phrase, “buy on the rumor and sell on the news.” The news, in this case, means the facts that may back an upward or downward breakout.

1. Learn the number of times to trade in the day

Following the announcement of a stock upgrade, the trader must understand when to buy or sell a stock. As a general rule, traders, especially retail investors, cannot trade with a stock in a single day for more than 4 times in a trading week (i.e., a 5-business day period). If the stock peaks slowly and the fundamental facts supporting the news is strong, then the trader should buy the stock at the end of the day and sell it the following day.

2. Apply the 3-day rule

Investors should also learn to wait for a few days (say, 3 days) for the market to confirm the news. Some stocks may react negatively to upgrades, especially if the market is yet to absorb the trading pattern. The investor needs to wait at least 3 days in case there will be a downward breakout. One may rush to sell if the stock starts to stumble, only to realize it is rising one to three days later.

Conclusion

This article explains how to trade on stock upgrades. They consist of announcements made by influential investment research firms indicating their positive rating about a stock mainly from sell or hold to buy. Stock prices react directly to these upgrades when supported by fundamental or financial backups. A rumor or overstated upgrade about stock will not have a lasting effect on the price.