Given all the headline talk about the upcoming Facebook IPO, it seems now is a perfect time to share my views and personal rules for trading newly listed companies.
Basically, I don’t trade a stock until it has at least 12 — but preferably 24 — months of trading history. That isn’t to say it’s not possible to make money in newly listed issues; it certainly is, given the right approach. However, my style includes strict requirements for the stocks that I trade, and new IPOs simply don’t fit the profile. Here’s why:
While investors might understand a company’s business model on the surface, there are sure to be some (or many) nuances to it that have the potential to change analysts’ outlooks for the company at a moment’s notice.
Take the case of Groupon (NASDAQ:GRPN), which had its initial public offering on Nov. 3, 2011, and issued about 40 million shares. The company had two restate its financials twice before its IPO, then once again after going public, on a series of accounting issues.
As a publicly traded stock, a company will be analyzed by a whole lot more eyes, and questions, opinions and misunderstandings will begin to run rampant. This adds serious additional uncertainty to a stock, and I prefer to focus on stocks where this risk is somewhat mitigated.
Stocks, just like human beings, have personalities. (Of course, that’s because they are being run and traded by human beings, but that is trading psychology — a topic for another day.)
Before I start trading a stock, I need to understand its personality. How does the stock act around earnings? How does it trade in different economic backdrops and political environments and seasons? What is the stock’s beta versus the benchmark index? How volatile is the stock in absolute terms? All of these things need about 12 to 24 months of history to be able to determine.
As a technical trader, I want to understand how a stock reacts to the various technical levels I monitor. This really is part of the stock’s personality, but given its significance, I think it deserves its own attention. At the very least, I need a 50- and 200-day moving average, which of course means I need at least 200 days of trading history.
How does the stock react to its major moving averages? Do they have a tendency to act as support and resistance or does the stock disregard them altogether? How does the stock react to overbought and oversold levels? Does it mean-revert quickly or slowly? What is the stock’s correlation to its peers and the overall sector it belongs to?
All these reasons (and more) are why I prefer to trade stocks with at least 12-24 months of trading history. Trading is difficult enough. You don’t need the additional uncertainty of a stock with little to no background.