At William O’Neil, we have a set of rules to take entry into a newly listed company. We advise investors not to buy a company’s shares on the day or during the week of its listing. For IPO stocks, there is no history of a price-volume action, so it is difficult to gauge the top. When it comes to investing in IPO stocks, new issues don't play by the usual rules.
Look for a base formation after a listing. Firstly, there should be a massive gain as the stock goes public and before it runs down after hitting resistance. A classic IPO base is a short and shallow area of consolidation that occurs right after a company’s IPO.
The framework of a good IPO base is simple:
The decline from a peak to low usually doesn't top 20%, but after a good gain on a listing day, the more volatile markets can have a decline of up to 50%.
The length of a base is often less than five weeks and can be as short as seven days.
On a listing day, the closing should be in the upper half of the day’s range.
During base formation, the stock price should not undercut the IPO price.
In an IPO base, the pattern should typically start within 25 days of the stock's first day of trading.
The standard pivot (entry point) is at the highest point on the left side from where a base pattern started to form.
In addition to these points, the other important aspect is volume. At breakout, the volume should be very high, and accumulation should be good just before a breakout (on the right side of the base). However, the volume of the first two-three days generally tends to be very high and should not be set as a benchmark.
The conviction becomes strong if the stock is among the leading industry groups. For India, we have 164 industry groups. Ideally, we prefer stocks among the top 40 industry group rank.
What next after the breakout?
From our study of different base patterns like cup-with-handle, double bottom, flat base, etc., we found that the highest success rate is of an IPO base. But, there may be a few stocks that fail after they break out from the IPO base. Ideally, after the breakout, we would not like to see a stock breach the pivot price and go back to the base. At last, our stop-loss rule of 8% can come at a rescue. If the odds are not in your favor, do not try to fight the market. Exit the position at a maximum loss of 8%. If there is growth potential in the company, the stock will rebound and give you another entry point in the future.
To understand this, let us take an example of Affle (India). On an intraday basis, it rose more than 20% and closed in the upper half of the day’s range. For the next two weeks, the stock fell but did not breach its IPO price and reversed from there. As shown in the chart, the volume dried up near the bottom, and a good accumulation started on the right side.