A Simple Technique to Profit From IPOs

Breathless commentary about this week's Snowflake Inc. (SNOW) initial public offering (IPO) stirred all sorts of greed and envy in the market community, but the vast majority of traders and investors have no idea how to play these over-hyped events, which are designed with the sole purpose of making money for insiders and Wall Street underwriters, both on the day of the issuance and in the sessions that follow.

Key Takeaways

  • The first trade of a newly issued equity can generate support or resistance for months or years.
  • Simple breakout and pullback strategies work well with IPO opening prints.
  • Use Fibonacci levels to locate short-term upside and downside targets in the first days of an IPO.

Fortunately, it's possible to get your bearings quickly when newly minted issues hit the ticker tape, so let's discuss a simple technique you can use to get up to speed. Just keep in mind that the vast majority of market participants should avoid all IPO exposure, like the plague, because the lack of price points can generate all sorts of dangerous situations. Twitter, Inc. (TWTR) offers a perfect example, now trading below the 2013 IPO price for more than six years.

An underwriter is any party that evaluates and assumes another party's risk for a fee. The fee paid to an underwriter often takes the form of a commission, premium, spread, or interest.

 IPO Opening Print – First Sessions

Chart showing the share price performance of Snowflake Inc. (SNOW)

The first price traded in the IPO session becomes immediate support or resistance, often for months or years. Place a horizontal line at that level on a one-minute chart right after the first trade of the day and use the inflection point to watch the action and consider short-term strategies. However, it can be risky to play the first pullback or breakdown because high volatility in the early stages of an IPO can overshoot levels, seeking value through intraday high and low prints.

We can see this at play on a Snowflake one-minute chart. The stock opened at $249.99 and was trading above $300 just three minutes later. It crossed the IPO print at the top of the hour but bounced strongly 23 minutes later, reinforcing support at $250 while setting off a profitable breakout signal for a scalping strategy. Note the Fibonacci grid stretched across the first price swing. This is an often-reliable method to find profit-taking levels or to place stops in the first trading days.

IPO Opening Print – Long-Term Impact

Chart showing the share price performance of Alphabet Inc. (GOOGL)

The importance of IPO opening prints can persist for months or years. For example, Alphabet Inc. (GOOGL) came public at $50 on Aug. 19, 2004, and rallied above the opening print for several sessions. The stock then sold off into September, returning to the magic price and bouncing strongly, as expected at this support level. A simple pullback strategy had the potential to produce windfall returns, with the stock rallying above $100 in the next two months and doubling once again into 2006.

Chart showing the share price performance of Facebook, Inc. (FB)

Facebook, Inc. (FB) carved another variation of this strategy following its botched May 2012 IPO. The new stock opened just above $42 and crashed, dumping into the mid-teens in September. The subsequent uptick completed a round trip into the IPO opening print one year later, triggering a breakout, followed by a pullback to new support in November. Both events set off buying signals that would have generated incredible profits for long-term positions.

A pullback is a pause or moderate drop in a stock or commodities pricing chart from recent peaks that occur within a continuing uptrend. A pullback is very similar to a retracement​ or a consolidation, and the terms are sometimes used interchangeably.

The Bottom Line

Place a line across the initial public offering opening print as soon as a newly minted issue hits the market, and use that level as support and resistance for trading and investment strategies that can last for minutes or years.    

Disclosure: The author held no positions in the aforementioned securities at the time of publication.

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