How to Trade the IPO "Sweet Spot"
Earlier this month, I alerted you to a left-for-dead trade that was finally starting to heat up: initial public offerings (IPO).
Fresh IPOs are just beginning to blast off after a painful dry spell. Two of the best performing names of the summer are newly listed stocks. Acacia Communications (NASDAQ:ACIA) is now up nearly 400% since it began trading in May, while Twilio Inc. (NYSE:TWLO) is up only 260% sine it hit the market in late June.
These gains are enough to make even the most seasoned trader salivate. But that doesn’t mean you should throw all your money at TWLO or ACIA and pray to the market gods that they continue to defy gravity.
If you’re going after new stocks, you need to know how to trade the IPO sweet spot. This strategy is the only way to safely play for the big rips higher while avoiding catastrophic losses.
Let me explain…
IPOs are one of the trickier trades on the market. It’s tempting to take a huge hack at them right when they begin trading– especially when you’re dealing with a hot name. Sometimes it pays off, and other times you might get burned. GoPro Inc. (NASDAQ:GPRO) is the perfect example.
You had a couple of opportunities for a swing trade when GoPro shares first hit the market in 2014. GPRO breaking out of its range in early September 2014 was the most “tradable” move. But like many IPOs, anyone looking to hold longer than a few days or weeks had to contend with a massive flameout after the September sprint.
After topping out and sagging for five months, GPRO gave up a majority of its initial gains and fell right back into its trading range.
Even if you timed the trade perfectly and bought as soon as shares went public, you would have given up most of your early gains had you held onto the stock through that first harrowing drop.
Unless you’re willing and able to trade in and out of an IPO, buying one before it even gets a couple of moving averages under its belt probably isn’t the move for you. Since our trading timeframe looks ahead more than just a few days, we want to wait for an IPO sweet spot instead.
Here are two ways to play the sweet spot, complete with real world examples:
The first setup is the coil that emerges when the IPO doesn’t race higher right out of the gate. Facebook is a great example of how this strategy worked for patient traders. The stock looked like a dud when it went public back in 2012. Once it failed at its highs on its first trading day, everyone complained the offering was overhyped and overpriced.
It took more than a year for Facebook to find its footing. But a picture-perfect sweet spot offered an ideal entry for anyone paying attention. The stock’s trading range compressed like a coiled spring and finally exploded higher in 2013. Once Facebook shares broke out, they never looked back…
Then there’s the boom and bust setup. Again, a little patience goes a long way. Here, you want to wait for the run-up and subsequent crash before establishing a position. This sweet spot can take a little while to materialize. Just look at GoPro. The stock trended lower for almost two years before setting up for an extended move higher.
GoPro is a great example of a stock that had to give it all back (and then some) before flashing a clear long-term buying opportunity:
GoPro’s drop in early 2015 turned into an extended bear market. We didn’t see the bottoming process begin until earlier this year. Instead of a coil, GoPro shares flattened out, forming a seven-month rounding bottom before breaking our in early August.
For longer-term IPO trades that won’t shake you out of your position or leave you with crippling losses, it’s all about waiting for the sweet spot. No, you won’t be in the stock from its very first day as a public company. But you will save yourself a lot of pain and suffering while the stock finds its legs.