LinkedIn and the Implications of Buying on the IPO Day

The success of the $LNKD IPO has just changed the exit strategy for all social media companies that are still private. The combination of small float and being the first U.S. based direct play of the social media trend produced wonders.

If you are a short-term trader, it does not matter if you use the service or if you understand it. All it matters is the volatility and the huge range that hot IPOs typically provide. $LNKD provided multiple opportunities for intraday traders and you didn’t have to buy blindly at the open to profit, on both the long and the short side. The stock built several high-probability intra-day bases with clear stop levels.

For swing-traders and investors, historically it hasn’t been a good idea to buy on the first day of the IPO. Most stocks perform poorly in the first six months after their IPO as underwriters and early buyers sell to lock in profits and mitigate risk. Even some of the biggest stock market winners in the past 7 years, struggled in the first few weeks after their IPO. Then they formed a base and broke out to a new high. You don’t have to chase by buying on the first day. Wait for the stock to establish clear zone of support and resistance; wait for it to prove itself by making a new high.

Take a look at the after IPO price action of $GOOG, $CMG and $OPEN.

 

 

 

No matter the story behind the IPO, it is never enough to sustain a long-term trend. A company needs to deliver a number of consecutive catalysts to sustain the expectations and fuel the price growth. At least this was the case with many of the biggest stock market winners – $GOOG, $CMG, $OPEN.

At the end of the day, catalysts drive stock prices. For the different time frames, different catalysts matter. Short-term price trends are fueled by momentum, medium-term price trends are fed by earnings related catalysts, long-term price trends are sustained by social and business trends. When it comes to a day to day price action, valuation is irrelevant. Traders don’t care about valuation. They just care about risk to reward and momentum.

Soda Maker Company Reaches An All-Time High

The producer of soda machines – $SODA, broke out to a new all-time high after releasing strong earnings report. The company announced that in Q1 it gained 0.27 EUR vs 0.15 EUR consensus estimate. It also raised its next quarter earnings guidance above the estimates.

$SODA has a very small float of 11.7M shares, one third of which is currently shorted. The market cap is under $1 billion.

An all-time high breakout + high short interest + small cap + small float has often been the perfect recipe for a major short squeeze.

Interestingly, the stocks of  most major beverage companies are trading very close to their all-time highs: $HANS, $DPS, $PEP, $KO. The Food and Beverage ETF – $PBJ, is also trading near major highs.

$SODA doesn’t sell soda. It targets the individual consumer market with machines for soda making. Its operating margin is nowhere near the soda industry average (6% vs 30% for $HANS). The U.S.A. is its fastest growing market.

Healthcare Stocks at the All-Time High List

More than 150 stocks reached an all-time high price level at some point today. Some of the highest volume moves came from the Healthcare sector. It is not a secret to anyone that follows the stock market that this is the sector that has been substantially outperforming over the past month (up 7.8% vs $SPY up 2.2%).

Let’s take a look at some of the big recent gainers in the sector.

$RMTI broke out to a new all-time high on April 28. The volume on that day – 5 times the 50-day average. The stock never looked back. It looked extended all the way up. Despite the humongous volume today, the stock closed far from the upper side of its daily range. It looks vulnerable to a pullback here.

$TRNX had an unsuccessful breakout attempt on March 21. It gapped up and gave back everything during the day, finishing at the bottom of its range. The second attempt for a breakout was way more successful. April 26. The stock was already in an established uptrend (10day MA above the 20 above the 50dma).

Not every breakout to new all-time high is a reliable signal. There are three additional factors that will improve the odds of success:

1) volume: the higher the better; it is an indication of institutional involvement.

2) catalyst (directly related to an earnings announcement or a sector move)

3) base: breakouts from long sideways ranges indicate a major development that has changed the supply/demand dynamics.

In hindsight everything seems so easy and clear, but when it has to be applied in reality, it is much more difficult. The equity selection criteria is often based on a study of the past winners. What traits did they have in common before they started their move? The truth is that many other stocks that share the same traits as the winning stocks will fail. It is really hard to differentiate them at the beginning stages of a new trend. Not every high-volume breakout to new all-time high from a good base will turn into a major winner. No one knew that when $OPEN gapped to $30 in February of 2010, it will go to 120 in the following year. No one knew that when $NFLX gapped up to $60 in January 2010, it will go to 250 within 12 months. The more one stock appreciates, the more it is studied and the nature of its move analyzed. As the price rises, the number of myths and explanations of the catalysts behind the move multiplies. Some of them are right, some of them are wrong. In the grand scheme of things, they are all irrelevant.

The real secret sauce is called risk management. Proper equity selection will help you to find the big winners, the stocks with the most potential for price appreciation. Risk management will help you to ride your winners long enough to make a difference in your returns and to cut your losses quickly, so you stay and thrive in the game.