There was a great amount of buzz last week over the initial public offering (IPO) of Snap, Inc. It was eerily similar to the noise surrounding previous IPOs like Alibaba (BABA), Twitter (TWTR), Facebook (FB), and GoPro (GPRO) when they opened. And the result was much the same with investors often getting blinded by the hype put out by the media.
If you believed the television and internet news surrounding the stock’s release, you believed that you would be able to buy the stock at the open and become rich on the first day. What an amazing profit potential if you actually had the chance to do this. Unfortunately most novice traders do not realize that this is nearly impossible to do.
In the case of BABA, the NYSE did not start trading for the stock until just before noon. The reason for this delay is that the specialists on the floor of the exchange needed to sort out the large imbalance between the stacks of buy and sell orders before the opening of the trading of that stock.
The very first trade was at $92.70, well above the $68 that most investors hoped to buy shares for. Within seven minutes BABA hit its high for the day at $99.70. Two minutes later the price dropped back down near the opening price.
Most retail investors were able to buy but would not have been able to sell until they received confirmation of their buy trade. With the volume of shares traded, it would have been nearly impossible to have made a quick profit. Looking at the price action and volume it appears that many stops were triggered as prices broke down.
Holding onto this “mega IPO” would have been costly too. It traded below and back to its opening price on the first day of trading but eventually dropped below the IPO price and took over a month to claw its way back up. There were a lot of frustrated investors out there and the media moved on to other topics.
Facebook was another IPO that soured many investors’ stomachs. On its first trading day there were so many shares being ordered that the NASDAQ computer system crashed! Once the dust settled, investors and traders had to wait for 15 months just to break even.
Twitter’s IPO didn’t fare much better.
Before you start thinking all IPO’s are failures, take a look at GoPro, Inc. (GPRO). It was successful from the start as shares continued to climb from the first trade.
The Problem With IPOs
The problem is that you do not know if your IPO is going to be a BABA, FB, TWTR, or GPRO. Stocks are a lot like people in that they develop personalities. There are many institutions and market makers trading the same stocks daily. When you identify the personality of the stock, you are more likely to successfully predict its behavior in both bullish and bearish markets.
IPOs have not developed their personalities yet. Even though supply and demand will work, you will have a higher probability for success on longer time frame trading and investing with an “older” stock. As a general rule, I avoid the newer stocks for any trading other than intraday and will not usually look to trade any stock with less than six months of trading history.
Lock Up Period
Another issue you have to face with IPOs is the “Lock up” period. When insiders or major institutional investors are given pre-IPO shares, they are prevented from selling them for 90 to 180 days from the IPO date. This is to prevent a massive drop in price when the stock is new. On average, only about 20% of a stock’s outstanding shares are available to the public at the IPO. If an insider were allowed to sell immediately, that could trigger a massive selloff of the shares and a significant drop of the price per share.
Since the IPO lockup period is 90 to 180 days, you may get a better chance at buying the shares after the insiders have sold them. When they dump, shares go on sale! Look at the same IPOs after that lockup period. Often you can time a potential short with the end of an IPO lockup or even look to buy shares when the insiders sell them into demand zones.
In our courses at Online Trading Academy, we teach our students how to screen for high probability opportunities and filter out stocks that may have too high of a risk to your capital. Learn how to find these and protect your money by joining us at your local center today.