Thinking of Buying the BABA IPO? Here’s What You Need to Know.

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Shares of Alibaba Group Holding (BABA) are scheduled to begin trading on Friday, in what will be the biggest initial public offering (IPO) in history — potentially growing as large as $24 billion (depending on the price the company sets for the stock on Thursday).

It’s going to be an historic event. But will investing in shares of BABA lead to historic profits?

Let’s take a look.

Participating in an IPO

There are two ways to participate in an IPO as an individual investor. First, if you’re lucky, you can get in at the IPO price — the price the company initially sets for the stock — by getting shares from your broker. We say “if you’re lucky” because, for all of this to happen, you not only have to be registered with and approved by your broker to participate in IPOs, but you also have to trade with a broker that has enough shares to go around for all of its approved traders. In other words, it’s often quite difficult to get shares at the IPO price as an individual.

Second, you can get in at (or hopefully close to) the opening trading price of the stock. This price may be lower than the IPO price if the company has priced the stock too high, or this price may be higher than the IPO price if the market is excited about the company’s prospects.

If the stock jumps higher at the open, it is certainly better to get shares from your broker. However, if you can’t get those shares, it is still possible to make a profit — either in the first day of trading if the stock continues to move higher after the open, or in the long run if the stock continues to move higher over time.

Evaluating the IPO

Seeing as how most of us aren’t going to get shares from our broker before trading opens on Friday, let’s evaluate potentially entering the IPO after the opening bell.

To do so, we are going ask two key questions:

  1. Is the stock likely to be overpriced or underpriced?
  2. What has happened with recent big IPOs?

Is the Stock Likely to be Overpriced or Underpriced?

This is an incredibly difficult question to answer, but we’ll give it a shot.

We anticipate that the stock is going to be slightly overpriced because of all the hype leading up to this record-breaking IPO. As soon as the valuation of the company’s business activities starts to play second fiddle to the idea of being a part of the biggest IPO in history, chances are good that excitement is going to trump prudence when setting the final IPO price.

So what does this mean for individual investors?

Some stocks are priced too low initially, and the market quickly reacts to correct the low initial pricing by sending the stock higher. When stocks are priced too high, however, the market doesn’t really have anywhere to take it, and the profit-taking by those early investors who now have a way to cash in on their investment tends to push prices lower. We anticipate BABA will fall into this category.

What Has Happened with Recent Big IPOs?

To show just how fickle IPOs can be, let’s take a look at the relatively recent Twitter (TWTR) and Facebook (FB) IPOs.

TWTR stock moved sideways for a few weeks after its IPO. It then soared higher before giving back all of the gains it enjoyed during December 2013.

Twitter (TWTR) After Its IPO

FB stock, on the other hand, jumped up on the day it started trading … only to lose more than half of its value during the next few months.

Facebook (FB) After Its IPO

Of course, FB has since recovered, but investors had to ride out a long pullback before the recovery.

As you can see, no matter how highly touted the IPO, there is no guarantee that the stock will continue to rise in the short term.

The Bottom Line for Individual Traders

Trying to get into an IPO after it has started trading is a gamble. Sometimes the stock continues to climb higher after it starts trading, and sometimes it starts to drop. While you could correctly say that is the same for any stock you are interested in trading, there are a few key differences.

First, other stocks you are interested in trading have a technical track record you can analyze. You can see exactly how the market in general — not just a few traders — has reacted to both good and bad news the company has faced. For instance, knowing where support and resistance have been established in the past gives you concrete information with which you can make a more informed decision. (That’s the bread-and-butter of what we do.)

Second, other stocks you are interested in trading have a valuation track record you can analyze. While you can look at the historical financials in the S1 documents the company files before the IPO and determine what the earnings per share (EPS) are for the company based on the IPO price, you cannot look at the historical P/E ratio to know whether investors are willing to pay a high multiple for those earnings or if they are only willing to pay a mediocre multiple.

Third, the volatility inherent in an IPO is naturally going to be much higher than for other stocks you are interested in. This increased volatility is almost assured because of all of the unknowns surrounding the stock.

Essentially, if you want to take on some increased risk in search of an increased return — after all, the two always go hand in hand — buying an IPO after the opening bell may be the strategy for you. On the other hand, if you’re looking for more data before you invest, IPOs probably aren’t for you.

The chances of there being a slight opportunity cost for waiting to trade a stock until all of the IPO madness has had a chance to work itself out are much smaller than the chances of losing big on a stock that plunges after its IPO.

John Jagerson and Wade Hansen are the editors of SlingShot Trader, helping investors capture options profits trading the news by using a proprietary 100% news-driven trading platform that turns event-driven pricing inefficiencies into fast profits. Get in on the next trade and get 1 free month today.

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Article printed from InvestorPlace Media, https://investorplace.com/2014/09/alibaba-ipo-baba-technical-analysis/.

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