Investing in IPOs can be massively lucrative as a hot stock can double or triple in price in a short time. However, it can also be equally risky because not all IPOs are born superstars. Unlike other listed stocks in the market, IPOs do not have a trading history. There is no way for you to evaluate how the market will judge the stock until it is listed.
Buying a stock at an IPO price does not mean that you are buying it at the bottom. It is simply priced according to how much the market is willing to pay. Some IPOs may be perceived to be relatively cheap based on growth prospects while others may be seen as expensive.
Until the IPO is finally traded on the stock exchange, you will never know where the stock is going. How do you now manage your risks when buying IPOs? Here are some mistakes every investor must avoid:
Losing the opportunity to take profits
IPOs can be volatile in the first few days of trading. Plan your selling strategy. You can lock in your profits once you have achieved your target returns shortly after listing day.
Unless you really believe in the IPO stock for long-term investment, take the chance to cash in on your gains whenever the opportunity presents itself. You can always decide to buy it back later when you are more comfortable with the trend of the stock.
Chasing IPOs on the first trading day
If you believe a certain IPO has potential and you want to buy more shares of the stock, it is best that you wait for a few more days for the stock to settle down before you start collecting. Historically, IPOs trade higher than their offering price upon listing, but all give in to profit-taking after a few days. Most IPOs recover after the first correction, which should give you a chance to earn a profit on a stock rally.
Following hypes, publicity
When a company is going public, underwriters want to make sure that the IPO is going to be successful no matter how unattractive the investment offer. Expect IPOs to be heavily promoted by underwriters because it is their job to sell them to the investing public.
Thus, avoid buying an IPO just because your broker recommended this to you or you just heard from your friend that the stock is many times oversubscribed.
Investing in brand recall
IPOs with familiar brand names are not necessarily good investments. Although a strong brand recall definitely helps in promoting the IPO, there is no guarantee that the stock will do well once it gets listed. Every IPO has a different story to tell. There are IPOs with good brand names, but no solid financials to show. Make sure that before you invest in IPOs, you first read the investment prospectus. Find out what the business model of the company is all about.
Investing with no stop-loss plan
Every now and then, there will always be a chance that you may invest in the wrong IPO stock and when this happens, be ready to cut your losses. Avoid getting so emotionally involved with the promise of an IPO that you forget to control your risks. Managing your risk is more than investing in the right IPO stocks. It is also about controlling your losses.
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