Trading IPOs is an exciting way to make spectacular gains. It’s also a great way to lose money.
Buying an IPO at the offering price, and then selling the stock soon after it starts trading on the open market, is known as “flipping,” and it is one of the riskiest ways to invest in IPOs. In fact, it is greatly discouraged by underwriters, especially if done by individual investors.
So I’m going to show you how you should be trading IPOs to maximize your profits and minimize your risk. And with the IPO comeback we’re witnessing, now is the perfect time for you to hone this trading strategy.
What to Look for When Investing in IPOs
Before we get to my trading strategy, though, I want to cover a few basics.
IPO stands for initial public offering, and refers to a company issuing its shares to the public for the first time.
Investing in IPOs requires that you do some homework, such as identifying early on which patents, trademarks and key executives can help take a company to new heights.
Think of it this way: If you were transported into the future by pressing “CTRL, ALT, F” on your keyboard, would the products a particular company is selling still be around? The answer to this and similar questions will help you to distinguish between the fly-by-night companies and the ones that are not going away any time soon.
Also, when selecting IPOs to invest in, make sure you take sector performance and industry growth into account.
You Don’t Have to be First to the Party … and You Don’t Want to be Last
Some of these newbie stocks skyrocket in the hours, days and weeks after they go public.
September’s hot issue, Lihua International Inc. (LIWA), which went public on Sept. 4, doubled by the end of that month.
While these kind of quick gains are enticing, and, yes, a lucky few do make spectacular profits, this is a risky game for individual investors. Even if you do get in on a nice run immediately after a company goes public, how do you know when to bail out?
IPOs trade erratically, and because it has no trading history, there’s no way to predict what the stock will do next.
LIWA hit its high of $10.69 in early October, and since then shares have given back about half their value. So, if you’re not careful, you could end up being the one holding the bag when the party is over.
That’s why I prefer to trade the secondary reaction versus the initial “out-of-the-gate” reaction. And that is where technical analysis comes in.
Waiting for the secondary move allows you the benefit of using the charts to guide you through the overall supply and demand picture. By trading the secondary reaction, you avoid whipsaw from buying high out of the gate, and then selling low out of fear.
Using Technicals to Trade IPOs
When trading the secondary move after a stock makes its public debut, I follow these steps:
1. Looking for a Consolidation
After a stock goes public, I watch it for one to three weeks and monitor its volume and trading range.
Volume should begin to decline along with the wild price swings as the stock begins to consolidate. We call that consolidation base building.
In the chart below, I have pointed out a rectangle as an area of consolidation.
2. Timing My Entry
I use technical analysis to determine when the stock is likely to break out of the consolidation pattern, and that is when I place my bet.
When a stock breaks out of a consolidation pattern, volume will start to rise again, as you can see in the chart example below.
3. Timing My Exit
To time my exit before the stock starts heading back down, I look for larger geometrical patterns, such as ascending triangles, cup-and-handles, and even shorter-term patterns like bull flags or pennants, as the stock begins to get some more time under its belt. (To learn how to identify some of these patterns, visit OptionsZone’s Technical Analysis 101 section.)
By identifying these, I can measure the distance or vortex, which is the actual width of whatever geometrical shape a stock happens to be in. This is how I come up with a price target for an equity that will allow me to exit at the top.
Options on IPOs
The best way to trade IPOs for the biggest percentage gains and the least amount of risk is through options.
However, not all companies that trade publicly have exchange-traded options. This is due to requirements that need to be met, such as minimum share price and minimum outstanding shares. Among the requirements is a minimum trading volume.
Prior to the IPO, there is no volume because the stock is not trading. But soon after the company goes public, if there is enough daily trading volume, that is typically all it takes to ensure sufficient interest and broker willingness to allow that stock to trade options, provided it is listed on a major stock exchange.
So, when it’s time to play the IPO’s secondary move, you will likely be able to do that with options.
Finding the Next Blockbuster Trade
So how do you trade IPOs if you don’t have a solid understanding of technical analysis? Well, that’s where I come in.
Stay tuned to OptionsZone, because in the coming weeks and months, I will be telling you exactly which IPOs I think are going to make monster moves higher and how you should play their secondary moves though options — including when to get in and when to bail out.
My first IPO recommendation — LogMeIn Inc. (LOGM) — is up 13.64% in the one week since I recommended it, while the options have exploded higher.
Don’t let the major opportunities of this IPO comeback we’re witnessing pass you by. With my help, you’ll be trading IPOs like a pro!
The old ways of investing don’t work anymore. But trading options founded on scientific principle can and does work in volatile times like these. In his latest report, learn how John Lansing leverages the power of technical analysis to identify the short window when a trade is set to go straight up or down. Get your FREE copy here!
