Tag Archive | "IPO Trading"

Successful IPO Trading Strategies


An Overview of the IPO Process

IPO ProcessDeveloping a clear understanding of the Initial Public Offering (IPO) process is important before delving into IPO trading strategies.  IPOs are an important part of the capital raising process in a market based economy.  Young and growing companies have a number of ways of raising the capital they need to initially expand and grow, from raising private funds to selling bonds.  Eventually, raising capital via private sources and the bond market reaches a maximum point and companies need to look for other sources of capital, which is where the stock IPO market plays an important role.

An IPO is just as its name implies, the first offering to the public of company shares.  The IPO process is a rather long, complex, and uncertain process, as ultimately market demand and conditions dictate whether or not an IPO can be completed.  The first step in the IPO process is an indication of interest by a private company looking to undergo an IPO and become a publicly traded company.  A private company will approach Wall Street investment banks, such as JP Morgan or Goldman Sachs, to discuss whether a stock IPO is a suitable way of raising capital.  If a stock IPO is a viable capital raising mechanism, the private company will sign a contract with an investment bank to manage and underwrite their stock IPO.  The investment bank collects a fee when the IPO occurs that is partially based on the ultimate value of the IPO.

The investment bank will assess market conditions and whether there is sufficient investor interest in the company’s shares to undertake an IPO.  If the IPO is ready to move forward, the next step in the IPO process is the filing of a S-1 securities registration statement with the United States Securities and Exchange Commission (SEC).  The S-1 filing is a very critical IPO document that IPO investors need to take a close look at.  The S-1 document includes:

  • the structure of the IPO
  • the financial condition and outlook of the company proposing the IPO
  • how the company intends to use the proceeds from the IPO

IPO Trading Strategies
The S-1 essentially explains a company’s internal operations, sources of revenues, potential business risks, the state of a company’s finances, and their plans for using the money raised from an IPO.

After the SEC approves an IPO S-1 filing, a company will undertake a “road show” to provide investors a chance to meet company management and ask questions.  The IPO underwriters set a date and price for the IPO, based on investor demand for IPO shares.   The stock then trades as a public company stock on a public stock exchange and the post-IPO stock price is determined by market forces.

IPO Trading Strategies | How to Buy IPOs

There are three ways to buy an IPO, each of which involves different IPO trading strategies.  All of the strategies involve various degrees of risk, due to the volatile nature of IPO trading.
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  1. Buying An IPO Before It Goes Public in the Private Stock Trading Market – A not so well known fact about private stock is that it can often be purchased through private stock trading platforms, such as SecondMarket.com.  If made available by company insiders, private company stocks that are likely to enter or are already in the IPO pipeline can be purchased by forward-looking investors.  The main limitation with this IPO trading strategy is that you have to be an accredited investor to buy shares on private stock trading platforms.  Individual investors can buy into mutual funds and exchange traded funds (ETFs) geared towards private stock investing to get involved in this aspect of IPO trading.  While this strategy can pay off handsomely, if a private company is purchased for just a fraction of the eventual post-IPO trading price, this strategy has some significant risks.  First off, a private stock may never go public in an IPO and the private stock may never realize full valuation.  Second, as was the case with Facebook (FB), the privately traded pre-IPO price can occasionally be higher than the public trading price, once market forces take over after an IPO.
  2. Buying An IPO Before It Goes Public By Obtaining An Allotment of IPO Shares – When an IPO has been approved by the SEC, the underwriters put out notices to stock market participants to see if they are interested in buying pre-IPO shares.  These shares are known as pre-IPO allotments, and are generally given out to preferred and large brokerage firm customers; however, some retail brokers, such as E-Trade and Fidelity Investments, set aside IPO shares for individual investors.  This is the least risky of the IPO trading strategies, since IPOs often trade higher while trading publicly after an IPO, at least initially and the risk of buying a private stock that may never go public is removed.
  3. Buying An IPO After It Goes Public Through A Public Stock Exchange – After an IPO has occurred, the price of the post-IPO shares are determined by market forces.  Buying stocks that recently underwent an IPO is a risky trading strategy because the stocks have no trading history and are often trade with a great amount of volatility.  Some post-IPO stocks rally after becoming publically traded stocks, while others incur sell-offs.  The key to successfully trading post-IPO shares is to identify and buy IPOs that market participants have undervalued for various reasons, and to avoid ones that are clearly overhyped and overvalued.  This strategy should be implemented with tight stop-loss orders to protect trading capital.


One post-IP trading strategy that can be quite effective is to buy shares a few weeks after an IOI occurs, then wait for the IPO quiet period to end.  The IPO quiet period is an SEC mandated amount of time both before and after an IPO in which analyst coverage and company news must be limited in nature.  Once the IPO quiet period ends, analysts often issue buy ratings for the stocks and the companies that underwent IPOs issue positive forward looking press releases, both of which can put upward pressure on the price of post-IPO shares, providing a potentially profitable trading opportunity.

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