Jan 31: The Simple Basics of Stock Trading – Trading with the Trends – IPOs

by David Jenyns on January 31, 2006

IPOs are the simple basics of stock trading and a part of the market that always generates a great deal of interest, along with stories of fabulous profits and spectacular losses. But, there are a ways to reliably profit on IPOs. Look for the trends that they cause and trade with them.

IPO spinoffs are a solid basics of stock trading trends to work with. A company that’s going to spin off a part of itself as an IPO tends to move steadily up in price until the IPO date, starting a week or two before that date. On the day the IPO starts to trade, the parent company`s stock typically dips sharply. The best strategy is to buy the parent once it starts moving in anticipation of the spinoff, sell it the day before the IPO is to begin trading, and then short the parent just after the IPO starts to trade.

Another basics of stock trading trend to consider is the `quiet period` trend. The `quiet period` for IPOs is the twenty-five days after a company goes public. During this time, the SEC forbids the company and the IPO`s underwriters to say anything that isn`t covered in the company`s prospectus or final registration statement. The underwriters face further restrictions on issuing any research.

Another basics of stock trading tip is that as stocks near the ends of their quiet periods, they tend to steadily rise in price in anticipation of the `strong buy` recommendations most will receive from their underwriters after the quiet period ends. The run-up usually begins about ten days prior to the quiet period expiration, and is often accompanied by steadily increasing volume. It`s wise to sell quiet period stocks the day before the recommendations come out. Why not hold the stock after it gets a `strong buy` recommendation? It`s another case of buy the rumor, sell the news. It`s also best to trade this trend with stocks that have highly respected underwriters and are in hot sectors.

Another basics of stock trading play is to short stocks with upcoming IPO lockup expirations. An IPO lockup is a period of time, usually from six to eighteen months, when insiders who obtained the IPO at the offering price or less cannot sell their shares. Once this time period has elapsed, insiders often sell their shares. This trend is shortable because the greater the number of shares unlocked, the more likely it is that insiders will start to sell their shares, particularly if the market is not doing well but the share price is still higher than the IPO offering price. And the more shares freed, the better the chance of a negative effect on the share price. This trade works best when the number of shares being unlocked is more than 25% of the current market capitalization.

You should short the stock roughly ten days before the IPO lockup expiration date, since anticipation of the event usually scares traders out of the stock well before its actual date. Cover the short about five days after the expiration date. By that time, most insiders will seem to have sold, and the news will be priced into the stock.

Like any other trade, these basics of stock trading tips are not foolproof. Often one of the underwriters will upgrade the stock as the lockup expiration approaches, or the company will release news to boost the stock price to counter-act the selling. Be sure to check company news closely, since if the market is bad and share prices are down, lockup periods may be extended.

But when the IPO market is hot, a lot of traders buy into any new company. They commit a trading mistake that`s like placing an overnight market order: They place market orders for an IPO before it starts trading on its first day, which leads to outrageous run-ups in price right when trading opens. For the trader, these orders are a sure way to lose money. Your order will end up being filled at a ridiculously high price that the stock may never see again.

If you`re going to try to trade an IPO on its first day, don`t place a pre opening market order. Don`t use market orders at all. The way to buy is with a limit order after the stock`s price has pulled back a bit and is about to bounce and continue upward again. The goal is to buy at the bottom of the bounce, hold it as the price rises, and sell just as the price is about to fall again. You may be able to do this several times, until the stock`s momentum drops. Remember, you can`t short an IPO during its first thirty days on the market.

If you want to hold the IPO past its first day, it`s hard to know exactly when to jump in, but wait until after the initial volatility has ended. The higher the IPO has opened the less chance it has of continuing to climb throughout the rest of the day. If the IPO has opened at an extremely high price, it will probably sink to a fairly stable level in an hour or two. If not, and you think the price could go higher, you might want to buy fairly soon after the initial volatility has ended. One option is to buy half your shares and then wait to see whether there`s a slump in the price later in the afternoon when you can buy the rest for less. IPOs can be incredibly volatile, and like with any other trade, setting stops is critical. But, traded carefully, these basics of stock trading tips are a consistent way to create trading profits.

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