IPOs – Trading or Gambling?

IPOs offer significant rewards, but not without significant risks

Some investors love trading initial public offerings (IPOs) because of their potential reward. Most investors, however, don’t realize the risks. Trading an IPO is a perfect example of blind trading. No matter how much research an investor has done, it isn't enough. This is simply because there is no information on the history of the security--no charts, no reactions to press releases, no reactions to good and bad market days, etc. Therefore, investing in IPOs is a gamble.

There are quite a few ways people lose money on IPOs. Many try to short the security, others try to buy and hold, while some are holding other securities within the same industry and lose money if the IPO is large enough.

An example of short sellers losing money is Rewalk Robotics LTD (RWLK). RWLK is a perfect example of a very successful IPO. The stock is up over 300% since the day of it’s initial public offering on September 12, 2014. Rewalk Robotics has provided a large return on investment, but many short sellers lost money. RWLK’s original offering price was $12, but it’s spike to $25 led many to short sell due to suspected overvaluation. However, RWLK shares then moved up to the $30 price range causing short sellers to lose big.

The large spike in RWLK's share price on the day of its IPO.

An example of investors with a buy and hold strategy losing money is Atento S.A. (ATTO), which had its IPO October 2, 2014. Atento immediately dropped 15% in price per share even though investors were buying shares left and right. Therefore, those who used the buy and hold trading strategy early lost big due to the company's overvaluation.

The large drop in share price since ATTO's IPO.

Finally, an example of investors holding other securities within the same industry and losing money is the largest IPO of the decade: Alibaba Group Holding Limited (BABA). BABA’s IPO price on September 19, 2014 was originally $50, but it quickly jumped to $68 before the market opened. BABA rose to over $100 in its first day of trading, but immediately dropped down 10% after the market opened, which was a huge set back for its shareholders. The only downside to BABA’s IPO, is that many hedge funds and private investors cashed out their shares of other tech stocks, resulting in a very red week for the industry. Google Inc. (GOOG) dropped a total of 4.5% and Facebook Inc. (FB) dropped 2% during the week of BABA’s IPO. And, these are just a few examples of tech stocks suffering due to the abnormal sell volume that week.

BABA's immediate 10% drop the day of its IPO.

Shown through the examples of RWLK, ATTO and BABA, whether you are short selling or buying shares of a company on its IPO, there is no way of knowing what the offering company will do. Of course, there are significant rewards when it comes to IPO investing, but there are also significant risks. As with any investment, and possibly even more so, do not invest money in IPOs that you are not willing to lose.