An Initial Public Offering, more commonly know as an IPO, is a term used for when a private company issues shares for the first time to the public. Generally companies that are completing an IPO are seeking capital to fund growth initiatives and in return, investors will receive equity in the company with hopes of appreciation in share value.
IPO’s can be risky for investors and traders because of the uncertainty involved with a new company and the lack of price action history, but with that risk can also come great rewards due to the volatility and price range IPOs have when they first start trading.
It’s important to understand that what you hear on the news for the IPO price will usually be different than what it opens trading at in the secondary market and this is because of supply and demand.
The IPO prices are hard to get unless you are a big client or an investment bank with deep pockets and the higher the demand for the stock, the harder they will be to get. Once shares are set to open in the secondary market, supply and demand will take hold and push prices higher or lower.
Stock held by insiders is restricted in a “lock-up period” from being sold for generally 90 to 180 days after the company goes public. This keeps too many shares from hitting the market and suppressing prices.
IPO: How It Works
When a company decides they want to go public there are a few important steps they have to take in order to complete the process.
The company will have to find an underwriter who will take charge of the process and will guide the company through the many obstacles. Underwriters are usually large investment banks that have plenty of resources to facilitate the public offering.
The company will have to organize and file all its financial statements and future outlook with lawyers, accountants and the Security Exchange Commission to make sure they are fit to be a public company.
Once approved, the company can file a prospectus with the SEC and set a date for the offering.
Warrior Trading Pro Tip
A good way to approach trading an IPO is to let it develop “price discovery” before jumping into a trade. This means you need to give price action some time to develop levels that you can use to trade against.
An IPO can be very whippy and volatile when first opened so if you’re not use to trading IPOs it’s probably best to let it cool off before taking a trade and using small size.