Demystifying IPOs: Understanding the Basics

If you’re looking to invest in the stock market, IPOs (Initial Public Offering) can be an option to consider. However, trading in IPOs can also be complex and risky, requiring a understanding of the process and research into the IPO of interest.

To take advantage of this opportunity, you’ll need IPO trading strategies that help you make the best decision for your trading goals.  There are many factors to consider and in this IPO guide, you will learn all you need to know about this instrument for trading.

What Is An IPO?

An initial public offering (IPO) is when a company transitions from private investors to public ownership, and this process involves underwriters, regulators, auditors, and lawyers.

IPO – SEPT 15 2021

IPOs have become popular among investors due to their potential for high returns, but not all IPO investments are successful. Investors need to be aware that IPOs come with risks. Before investing in an IPO, do your own research and understand the company’s background, promoters’ reputations, risks involved, and plans for the funds raised.

Always read the red herring prospectus before investing in an IPO. Know where your funds are invested and if the company is raising capital for expansion or research. One important factor in maximizing your returns during an IPO is setting benchmarks against which you can judge the company against other companies in the same sectors.

Valuations matter when it comes to investing in these stocks. Also have a solid exit strategy planned out ahead of time so that you can sell your shares at specific levels. Understanding lock-in periods is also something to know as these periods prevent insiders from selling their shares immediately after the stock goes public.


How Does The IPO Process Work?

The IPO process involves several parties, including regulators, auditors, lawyers, and investment bankers.

It begins with the company filing a registration statement with the SEC that includes a prospectus detailing its business model and financials. The prospectus is an important document for investors as it outlines the risks associated with investing in the company.

Once the SEC approves the registration statement, investment bankers begin marketing shares to institutional investors such as pension funds and hedge funds. These investors are given priority allocation of shares before retail investors can buy them on the open market.

As demand for shares increases, so does their price (supply and demand in action). On the IPO trading day, retail investors can purchase shares at market value.

Not all companies going public are profitable or have proven business models. Look past the hype surrounding a new offering and analyze a company’s financials and even the management team to determine its potential for success.

relianceReliance Power in 2008 was hyped and popular before hitting the market with a speculated value of $190 billion. A few days after listing, shares crashed and hit a low of $1.00.


Alternative Methods To IPO Trading

SPACs, or “special purpose acquisition companies”, are shell companies created for the purpose of merging with a private company and taking it public.

One advantage is that the process can be faster than a traditional IPO. There are risks involved such as potential conflicts of interest between SPAC sponsors and shareholders.

Reverse mergers involve a private company acquiring a publicly traded shell company in order to become listed on an exchange. This method can also be quicker than a traditional IPO but carries its own set of risks. The financial information provided by the shell company may not reflect the new company’s financial health, leading to investor distrust.


Also, these types of deals are often used by struggling companies as a last resort to stay afloat.

When it comes to IPO trading strategies for alternative methods like SPACs or reverse mergers, day trading can be particularly risky due to limited data available on these lesser-known companies.

In 2020, Virgin Galactic, a spaceflight company under the Virgin Group, went public through a SPAC led by Social Capital. The SPAC, called Social Capital Hedosophia Holdings, raised $700 million in a 2017 IPO. In 2019, it merged with Virgin Galactic, valuing the company at $1.5 billion.


Conducting Research

One key aspect of conducting research is analyzing the preliminary prospectus. The preliminary prospectus provides a wealth of information about the company, including its business model, financials, and management team. By reviewing this document, you can develop a better understanding of what makes this particular IPO unique and whether it line up with your investment strategies.

Another key component of conducting research is staying up-to-date on market trends and news related to the IPO. This includes monitoring social media channels, financial news outlets, and industry reports to stay informed about any major developments that could impact your investment decisions.


External Resources

When it comes to IPO trading strategies, having access to external resources is a good tool to have. These resources can provide you with valuable data points, analytics, and expert opinions that can help you make informed investment decisions.

One of the top external resources for IPO trading is investment research firms. These firms specialize in conducting due diligence on companies going public and providing comprehensive reports on their financials, competition, market trends, and growth potential.

IPO RESEARCH FIRMSBy reviewing these reports, you can gain a better understanding of the company’s strengths and weaknesses and determine if it aligns with your investment objectives.

Reputable financial publications like The Wall Street Journal or Barron’s are excellent sources of information for IPO investors. These publications often feature articles written by experts in the field who analyze market trends and offer insights into specific company offerings.

Keeping up-to-date with these publications can give you an edge in making informed decisions about which IPOs to invest in.


S1 Document

The S1 document is filed by companies during their registration process with the SEC and contains all relevant information about the business. This includes:

  1. Details on the company’s management team
  2. Financial statements
  3. Risk factors
  4. Market/sector trends
  5. Projections for future growth

This document is an essential tool for IPO trading strategies as it helps investors understand the direction a company plans to take in the future.

Lockup periods are also mentioned in this document that restricts insiders from selling their shares immediately after listing on public exchanges. Understanding these periods can help first-day traders plan their exit strategy accordingly.

Apart from studying the S1 document consider external resources when formulating your IPO trading strategies. These include analyst reports and news articles discussing industry trends that may affect a company’s performance post-IPO.  Remembering lockup periods while planning your exit strategy ensures that you get maximum returns from your investment before the insiders dump their holdings.


Red Herring Prospectus

This document provides a detailed look at the company’s background, management team, financials, and plans for using the funds raised through the IPO. As an investor, this is valuable information that can help you decide whether or not to invest in the company.

When examining the Red Herring Prospectus, pay attention to any red flags. Look for information on company insiders and their involvement in previous ventures. Take note of any hot IPO markets and anchor investors who have already invested in this particular offering. These factors can indicate whether or not there is strong interest in the company and if it’s worth investing.

It’s also important to analyze how the company plans to use its funds.

Are they raising capital for expansion or research?

Will they be paying off debt?

Understanding these details will give you insight into how successful the company may be in achieving its goals post-IPO.


Valuation Considerations

Valuation considerations are crucial when investing in IPOs because the offering price is often based on the company’s perceived value, which can be an over or underestimation. Determining whether the price is fair could lead to profitable returns or substantial losses.

When evaluating an IPO position, market capitalization is a critical consideration. Market capitalization represents the total value of all outstanding shares of a company and is calculated by multiplying the number of outstanding shares by its current stock price.

Early-stage firms typically have smaller market caps than well-established companies but can still be worthwhile if they have solid growth prospects.

Another metric to consider when investing in early-stage companies is revenue growth potential. It would help if you analyzed how fast the company has been growing and compare it with other similar firms in its industry. This information will enable you to assess whether it has potential for future growth.


Market Methods

It’s important to understand the difference between primary market and secondary market methods.

Primary markets refer to IPOs where shares of a company are sold directly to the public for the first time.

Secondary markets involve trading already issued shares through stock exchanges.

When evaluating IPO trading strategies, consider investment banks’ role in underwriting initial offerings. Investment banks work with newly public companies by providing financial advice and managing marketing efforts aimed at attracting investors. In return, they receive fees from these transactions. Companies which partner with top-tier investment banks tend to fare better than those who don’t.

Another approach when analyzing market methods is understanding the benefits of each type of offering. While primary market offerings offer access to a newly listed company at an early stage and often at lower prices than available on secondary markets, there’s limited information available about these companies due to their recent entry into the public trading sphere.

Investing in already traded shares via secondary markets offers greater transparency regarding information about a company’s performance over time.

Determining which method suits your investment strategy depends on your risk tolerance level and desired returns. Consider factors such as historical data on similar stocks within your chosen sector(s), size of the company going public/already traded (i.e., mid-cap versus large-cap), industry trends (e.g., tech or energy) before making any decisions.


Fund Investment and Management

Fund investment is a popular method for diversifying your portfolio without having to manage individual stocks or bonds. These funds pool together investments from multiple investors and use them to purchase securities that align with the fund’s investment objectives.

When it comes to IPO trading strategies, fund managers have various portfolio management strategies that they use when investing in newly listed companies. Some managers may use an active approach, where they buy and sell shares based on market conditions and company performance.

Others prefer a passive strategy, where they hold onto shares for an extended period with the hopes of long-term growth.

Investors should consider several factors when choosing a fund manager. The manager’s experience, track record, and investment philosophy are all important things to consider. Investors should examine the fees associated with each fund before making an investment decision.


Promoters and Management

The success of an IPO depends on the people behind it. You want to invest in companies that have a responsible management team with a successful track record in their industry.

Do your due diligence and research the backgrounds of key executives, including their experience, education, and reputation. When evaluating promoters and management, it’s important to look for transparency. A company that is upfront about its financials and operations is more likely to be trustworthy than one that hides information.

Read through the red herring prospectus to understand what the company plans to do with the money raised from the IPO. If there are vague or unclear statements in this document, that could be a red flag.


Broker Selection

When it comes to selecting a broker for IPO trading strategies (or any trading), transparency and reputation should be some of the top factors to consider.

The quality of advice you receive from your broker can have a significant impact on your investment’s success. Reputed brokers can provide valuable insights into market trends, investor sentiment, and company evaluations.

Some major investment banks like Goldman Sachs and Morgan Stanley make substantial profits in IPOs. While they’re reputed brokers, investors must exercise caution while choosing them (or any company) as their broker. It’s essential to research the bank’s track record and analyze its past performance in handling IPOs before making a decision.

Investors must also evaluate how brokers differentiate themselves based on their quality of management. A strong management team with experience in managing public companies is an integral factor that ensures successful IPOs for investments.

Brokers who conduct thorough due diligence on management teams can provide invaluable insights into the company’s future prospects.

5 IPO Trading Factors

To effectively trade in the IPO market, you need to consider various trading factors. These include company volume, market sentiment, and financial data.

Factors Affecting IPO Trading
Company Volume
Definition: Number of shares available for trading on the first day of an IPO
Impact: High demand can lead to price increases, while low demand can result in price drops
Market Sentiment
Definition: Positive or negative perception of the company or industry
Impact: Positive news creates bullish sentiment and drives up prices, while negative news creates bearish sentiment and pushes down prices
Lockup Period
Definition: Time during which insiders are prohibited from selling their shares after an IPO
Duration: Typically 90 days to six months (depending on company policies)
Impact: The end of the lockup period may lead to insider selling, potentially driving share prices down
Definition: Evaluation of management’s track record and experience
Considerations: Past performance, reputation within the industry
Impact: Assessing management helps determine their ability to run the business effectively
Trading Strategy
Recommendation: Have a well-defined strategy
Steps: Analyze market conditions, set entry and exit points based on risk tolerance and profit targets
Risk: Investing in IPOs carries significant risks due to limited financial performance history

Watch For Volume In The Stock

Volume is an essential factor in determining the interest levels of investors in a company. It represents the number of shares being traded on a particular day, and it can indicate whether there is high or low demand for a stock.

On the first day of trading, it’s important to monitor the volume as it can provide valuable insights into market sentiment towards the IPO.

High volumes indicate strong investor demand and may result in increased prices.

Low volumes could mean that there isn’t much interest in the stock, which may lead to lower prices.

Also consider volume when deciding the trading positions you will take. If you plan on taking a long position on a hot IPO, make sure that there’s sufficient volume to allow for easy entry and exit from your trades.

On the other hand, if you’re interested in shorting an overvalued IPO, ensure that enough supply exists in order to avoid getting stuck with illiquid positions.

Analyzing volume alone shouldn’t be your sole strategy for trading IPOs. Other factors such as company fundamentals and market conditions also play roles in determining price movements during the process.


Limited Data Challenges

As an IPO trader, you need to analyze all available data, including the S1 document, to understand the company’s strategy and revenue.

However, underwriters often limit the information provided, making technical analysis difficult. Therefore, it’s essential to rely on external resources like financial news websites or expert opinions to form a well-informed view.

When trading IPOs on their first day of listing, there are no rules or guarantees of success. The stock price can fluctuate wildly due to high demand from retail investors and institutional buyers. It’s important not only to consider the volume but also other metrics like sector performance and investor sentiment.

Additionally, be aware of lock-in periods that restrict selling for insiders and underwriters as these can impact profit per trade.

While investing in an IPO may seem lucrative at first glance, it comes with a higher level of risk than traditional trading. Limited data makes it challenging for traders to predict future market trends accurately.


Time To Trade The IPO

When it comes to trading time for IPOs, here are some important factors to consider:

Topic Information
Institutional investors Keep an eye on how institutional investors react in the first few days of trading. If they buy shares at the current IPO prices, it’s a good sign that the company has strong potential. If they sell shares, it indicates underlying issues with the company’s financials.
Offering price The offering price plays a major role in determining when to trade an IPO. If the offering price is too high, it may take longer for the stock to reach its resistance level and see significant gains. Lower-than-expected prices may generate more early interest.
Resistance level Understanding where market action will face resistance can help determine whether or not to invest at certain times. Consider using technical analysis indicators like moving averages or trend lines that might indicate potential resistance levels.
Trading strategies Every trader has their own approach when it comes to timing IPO trades. Some opt for short-term trades immediately following an IPO, while others hold onto shares for the long haul. Have a clear strategy in place to avoid impulsive decisions based on market fluctuations.

Timing your trades around key events such as lock-up periods or earnings reports can also play a role in maximizing profits from IPO investments.


First Day Trading

The opening price can be significantly higher or lower than the offer price, so you must have a trading plan that includes stop-loss orders and exit points.

When analyzing volume on the first day of trading, pay attention to whether there is sustained buying or selling pressure. If there is high demand for shares, you may consider holding onto your position for a longer period to take advantage of potential gains.

If there is low demand or selling pressure, it might be wise to exit your position quickly.

Also consider market sentiment when trading IPOs on their first day. If overall market sentiment is negative, IPOs tend to underperform as investors are less willing to take risks. if market sentiment is positive and optimistic about future growth prospects, IPOs may perform better.


Secondary Market Approach

Unlike IPOs, these companies have a history of trading activity and financial performance that provide valuable insights into their potential for growth. Traders who adopt a secondary market approach can use this information to identify investment opportunities that align with their investment objectives.

Here are four key benefits of the secondary market approach when it comes to IPO trading strategies:

Increased liquidity: Because companies on the secondary market have already gone public, there’s generally more volume and liquidity than with IPOs. This means traders can buy or sell shares easier and at prices closer to fair value.

Historical data: Trading activity on the secondary market provides historical data that traders can use to base their trading decisions. This data includes trends, volume patterns, and analyst reports.

Reduced risk: Since these companies have been publicly traded, they tend to be less volatile than newly listed IPOs. This reduced risk allows traders to take a longer-term approach to investing without worrying about sudden price swings.

Diversification opportunities: The secondary market offers a range of industries and sectors from which traders can select stocks according to their investment objectives. By diversifying across different sectors and industries, traders can reduce portfolio risk while increasing returns over time.


Exit Strategies

Exit strategies must be used to maximize profits while minimizing losses when trading.  Here are some tips for effective exit strategies:

Determine profit-taking levels: Set a target price for selling your shares that will allow you to take a profit. This level should be realistic and based on the company’s valuation, financials, and growth potential. Don’t get greedy or chase unrealistic gains.

Use stop-loss orders: A stop-loss order is an automatic sell order that triggers when the stock price reaches a certain level below your purchase price. It helps limit losses if the stock price drops unexpectedly.

Understand the IPO lock-in period: Many IPOs have a lock-in period during which insiders and early investors cannot sell their shares. This can affect supply and demand dynamics, so consider this factor when planning your exit strategy.

Stay disciplined: Stick to your exit strategy even if emotions are pushing you to take action. Avoid making impulsive decisions based on short-term market movements.

Implementing an effective exit strategy requires discipline, patience, and research. Plan ahead before investing in an IPO by setting profit-taking levels and using stop-loss orders as protection against downside risk.

Keep an eye on the lock-in period of any given IPO before deciding on an exit strategy as it may impact supply-demand dynamics once it ends.


Should You Buy An IPO On The Day?

If you are interested in being involved in an IPO, waiting for the hype to clear can be an effective approach.  Traders can use consolidations as the market digests the new stock price, to find an entry.  This way, you are not jumping in with the crowd only to see a quick reversal in price.

Investment Bank Profits

Investment banks are raking in substantial profits by helping private companies go public through Initial Public Offerings (IPOs). These underwriters play an important role in the IPO process, providing financial advice and facilitating the sale of shares to investors.

They earn fees for their services, which can amount to millions of dollars per deal.

While this may seem like a larger price tag for companies going public, it’s worth it as investment banks bring credibility and market expertise to the table. As an investor looking to trade IPO stocks, it’s important to understand the role that investment banks play in the process.

Investment banks act as intermediaries between companies and investors, helping them navigate complex regulatory requirements. They also help price the stock appropriately based on market demand and supply. By understanding how these underwriters operate, you can gain insights into how IPO stocks may perform in the aftermarket.

When developing your IPO trading strategies, it’s important to consider your investment objectives.

Are you looking for short-term gains or long-term growth?

Do you have a high tolerance for risk or are you more conservative with your investments?

Understanding your goals will help you determine whether investing in an IPO makes sense for your portfolio. It will also guide your decision-making when selecting specific IPO stocks to trade.


IPO Company Examples

Amazon, which went public in 1997 at $18 per share. Today, it trades at over $115 per share and has become one of the biggest companies in the world.

Another example of a successful IPO is Facebook’s debut on the NASDAQ in 2012 at $38 and rising to a high of $378.00. Despite initial technical glitches on the exchange, Facebook’s shares quickly recovered and have since seen significant growth.

Not all IPOs are created equal. 

Companies like WeWork 2019, Snap Inc 2017, and Groupon in 2011 were anything but stellar.  Some private companies may look promising but ultimately fail to deliver results once they go public.


Frequently Asked Questions

What Is a Red Herring Prospectus?

A Red Herring Prospectus (RHP) is a preliminary document in a securities public offering. It provides detailed company and securities information, excluding price and shares. The RHP aids informed investor decisions but should not be the sole basis. The final prospectus, including price and shares, is relied upon for investment decisions.

What does IPO mean in the context of trading?

IPO stands for Initial Public Offering, which is the process of a private company going public and offering its shares to the public for the first time in the stock market.

What is the process of trading IPO shares?

To trade IPO shares, you typically need to have a brokerage account, access to IPO offerings, and place buy or sell orders through your broker during the IPO’s trading window.

When is it permissible to commence trading an IPO?

IPO shares can be traded once the company goes public and the stock is listed on the exchange, usually within a few days after the IPO date.

Are there inherent risks associated with IPO trading?

IPO trading carries inherent risks such as market volatility, price fluctuations, and the uncertainty of a newly listed company’s performance.

How can one generate income from IPOs?

Making money from IPOs can be done through strategies like participating in IPOs at offer price, selling shares during the initial trading surge, or holding long-term if the company performs well.


Successful IPO trading requires a combination of knowledge, experience, and careful planning.  It is easier to trade established companies and their stocks due to historical price data available.  Additionally, it is important to stay up-to-date on news and developments related to the company and its industry, as this can greatly impact the stock price.

Have a clear understanding of your investment goals and risk tolerance before investing in an IPO. Proper research and due diligence can help investors make informed decisions and increase their chances of success in IPO trading. Overall, with the right approach and preparation, IPO trading can be a profitable investment opportunity.

Author: CoachShane
Shane his trading journey in 2005, became a Netpicks customer in 2008 needing structure in his trading approach. His focus is on the technical side of trading filtering in a macro overview and credits a handful of traders that have heavily influenced his relaxed approach to trading. Shane started day trading Forex but has since transitioned to a swing/position focus in most markets including commodities and futures. This has allowed less time in front of the computer without an adverse affect on returns.