Should New Investors Trade Initial Public Offerings?

I was over at Chris’s site just now and ran across his post on how to Make Millions Trading IPOs and found it pretty interesting. Chris is a good friend and a avid CANSLIM trader, and this really got me thinking in terms of the new investor, should you really be getting involved in these high risk investments?

What Are Initial Public Offerings (IPOs)

The initial public offering process is actually a pretty straight forward concept. An IPO occurs when a stock that is currently privately held decides it wants to raise extra money by going “public”. The whole point of an IPO is to raise capital for expanding the company. The trade off of any IPO is that your company is no longer private and is forever under scrutinty by market analysts and the general public.

IPOs are considered dangerous because the first day the company is publicly traded under its new stock symbol the stock price typically fluctuates a lot (you can’t buy the stock until its first day). The first few weeks are even more dangerous as the stock either makes headway and pushes ahead or pulls back in price. For example stocks like Mastercard (MA) and Google (GOOG) did very well there first few months and still are growing strongly today. On the other hand you have companies like Vonage (VG) who’s stock price fell sharply its first few months of trading publicly.

Trading IPOs Successfully

As a new investor you are going to be getting used to your online stock broker and just trading in general (see my post on how to buy stock) , so should you mess around with these risky new companies?

Well, one thing is sure, they can definitely be profitable. Chris gives some great examples of stocks that did very well over a three month time period shortly after their IPOs:

  • JASO, 59.63% gain
  • SNCR, 50.65% gain
  • GTLS, 34.75% gain
  • DVR, 9.15% gain

If you read through each of these stocks, you can see very clearly Chris knew exactly what he was looking for and how to play each stock individually. Looking at how Chris broke down these plays, I would say you would need to have a strong understanding of the following concepts (mostly all have been covered on this blog):

  1. How to read stocks charts which covers the basics behind reading a stock chart.
  2. Volume interpretation with stock charts which breaks down distinguishing a accumulation day versus a distribution day on a stock chart.
  3. 60 stock market tips for success, these are weighed from the CANSLIM style of trading, which is what Chris actively uses.
  4. An understanding of institutional support and overall strong fundamental analysis.

Now, not all IPOs need to be traded exactly the same way Chris goes about them, but this is just one way to trade them successfully. Chris has years of experience in the stock market, and it is very apparent throughout his posts.

So should new traders invest in IPOs?

I would say no. If you are a new trader just taking the reigns this may not be the best place to put your money. Chris has shown us that they are successful when you know what you are looking for, but the case and point as a new trader is that we don’t know exactly to look for. The extra risk attached to buying into a brand new stock is just not worth it.

I would give a fresh new IPO stock atleast 3 – 6 months before considering it as a trade. Otherwise stay away OK? :twisted:

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Comments

  1. says

    Blain,

    I agree with your opinion that new traders should probably stay away. The IPO market brings in these new companies, which we generally know little about, which can be very tricky. Advanced traders may be able to make a mint, but there also plenty of people who get burned.

  2. says

    Nice post and thanks for the link love! Ipos are dangerous for novice investors. They can be deadly for anyone. However, they are great risk-to-reward plays during strong up-trending markets. Look at VMW (I missed that one).

    I like BX long term with a buy closer to $20 to $22 (not at current levels).

  3. says

    Yeah, I was going to point out VMW, although IPO’s like those only come once and while. It is also pretty hard to get into IPO’s for a launch (at least in my experience).

  4. says

    I’ll agree that IPO’s need to settle out and form some kind of pattern before initiating position. A few months is probably a good time frame but from what I’ve seen in my analysis the best IPO’s DO NOT form large bases. Breakouts from short triangle patterns in a strong market can yield big profits. – Tate

  5. Mikel says

    If you do your research correctly and you are ready for the risk, you should be able to do what you want with your own money :)