How I Will Trade Facebook’s IPO On the First Day

Posted on May 17, 2012 by

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A strategy I’ve used in the past for high-tech IPOs. It is simple.

keywords: computing for finance, IPO, first day pop

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First things first

Trading an IPO on the first day is risky. I am not providing trading advice here, I am just sharing my own trading plans. If you are considering to also trade Facebook on the first day, make sure you do it only with money you can afford to risk.

Important updates:

Strategy NOT triggered (May 18, 12:01PM)

After a nail-biting open at $42.00, FB promptly sank and scraped along bottom at $38.00. It’s now recovering. In any case, the strategy I outlined here was NOT triggered.

FINRA Rule (May 17, 2012, 3:00PM)

Thanks to a colleague for pointing out this story: FINRA prohibits Market At Open orders for IPOs. This rule does not affect my plan though, because I will only enter an order after trading has commenced. For more detail, look at the FINRA notice.

Delayed Open (May 17, 2012, 4:00PM)

Market open for Facebook will be 11AM according to NASDAQ.

Priced at $38.00 (May 17, 2012, 5:32PM)

Facebook Inc. set its final price at $38 a share, as the social network gets ready for its historic initial public offering on Friday.

Background

This trade is not at all about investing in Facebook.  It is entirely about taking advantage of the often observed “first day pop” associated with tech IPOs. Consider how the following stocks performed on their first day:

  • Yelp, +64%
  • Zynga, -5%
  • Jive Software, +25%
  • Angie’s List, +25%
  • Groupon, +31%
  • Pandora, +9%
  • LinkedIn, +100%
  • Demand Media, +33%

Most of these stocks gained substantially on the first day. Compared to these other stocks, Facebook has significantly more real value. For that reason I believe we’ll see a strong first day pop.

Note that even if one trades very well, it probably is not possible to get the full “pop.”  The “pop” is the difference between IPO pricing and market close of the first day. The first price you see on the exchanges is usually higher than the IPO pricing. This is because the IPO will be priced and sold to clients of the banks who are backing the IPO. Then they, in turn, offer the shares for sale on the exchanges. The final price available at market will probably be higher than the initial IPO pricing.

Confirmation step

Whenever possible, I like to have confirmation of the hypothesis we’re relying on for the trade. In this case, our hypothesis is that there is very strong demand for the stock that will drive its price up. For this trade, I’m going to wait for two upward ticks after the opening price. If the first tick is down or level, I’ll wait for three consecutive up ticks. If the first tick is significantly down, I’ll abandon the entire trade.

Preparation & Execution

I will set up my trading platform (I use thinkorswim) so that I can very quickly execute my entry and exit trades. On my platform I can define both trades and click on them one after the other as soon as I’m ready.

  • Trade 1: buy at market
  • Trade 2: sell with trailing 1% stop loss

Once the confirmation step is confirmed, I’ll enter the buy at market order. I’m usually not a fan of market orders. But in this case there will be substantial liquidity so the risk of an adverse execution is low. Also I want to get in fast and not lose any upside opportunity.

As soon as I’m in, I’ll submit the trailing stop order. The 1% trailing stop will be triggered if the price drops 1% below my entry price, and it will move up as the price moves up.  The general idea is that we’ll accept all the upward movement, but get out as soon as it starts to drop. If the stock climbs significantly, I might revise the trailing stop to 2 to 5%.

The idea for a “tight” trailing stop initially is to limit downside risk. Overall, if things go just the wrong way, I think there’s a risk of a 2% loss. Once I’m out of the woods, and they stock has climbed away from the entry price, we can relax the stop so it doesn’t get triggered by a small short drop.

Exit before the close

Remember, I’m not investing, I’m trading. This is a one day strategy. If my trailing stop is not triggered before 3:00PM, I’ll gradually “tighten” my trailing stop until it is triggered by a momentary drop.

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