On: March 19, 2015 In: Feature Comments: 0

IPO

By Janine Cox

Who wouldn’t want to make money in a few days or weeks? Some short term traders chase company floats in the hope of picking a few that rise by 20, 30, or even 100 per cent above the buy price after listing. The problem is that company floats are high risk and most don’t have the training to manage their risk, or their egos. Before I get into the subject of floats, it’s so important for you, the trader, to take a good honest look at yourself, and your ego. Songs have been written about the human ego, wars have been fought because of them, and the general consensus is that men tend to have much bigger egos than women. That aside, these days it’s not only men that get led astray by their egos as they try to get rich quick in the share market.

When I started in the share market many years ago, I observed at trading seminars how between five and ten per cent of people in the audience were women. Today at Wealth Within, women are closer to 35 per cent of all entrants, which shows how the balance of the sexes in the share market is changing. While I have come across many men who could be likened to ‘cowboys’, taking high risks in the share market, I have met only a few women that I could call ‘cowgirls’. I recall a lady who admitted that she was a ‘cowgirl’, until we helped her reduce risk by showing how to put some structure and solid rules around trading.

While we all need an ego to get out of bed in the morning, an ego out of control can lead you to make very costly mistakes.

Let’s talk floats

Whether you are a trader, or an investor wanting to learn to trade, it is important to know early on that buying into company floats is high risk. What is really concerning is how many investors believe that buying shares this way is safer and lower risk than buying on market. However, in my opinion this is just another share market myth that stems from a lack of knowledge about the market and how it works, which in the end will cost you. Your odds of picking a successful company float could be likened to putting money on red or black on a roulette wheel, as the statistics indicate that around 50 per cent of all floats trade below their issue price within the first 12 months, which means you have a 50/50 chance. Some even fall below the issue price shortly after they list. Now for me, these odds are not high enough to justify the risk.

As a trader, I prefer stocks that have been trading on the market for at least two years so that I have the minimum amount of data I need to make an educated decision. Ten years of data is ideal, however, depending on the stock there may not be this much history. Analysing historical price data can provide you with a reasonable indication about the stock’s future price, which is something you cannot get from a prospectus.

History shows that you can reduce your risk if you only buy into the more liquid companies that list in the top 100 stocks, or government floats. However, even government floats can trade below the issue price in the months post float, so for those determined to buy, you may have paid less had you waited. Also, this means that the market has had an opportunity to value the company, as often in the months after the float the company will be required to report to the market.

The timing around when the company lists can also be important. If the float occurs when the market is bullish, positive sentiment is more likely to support a rise in the share price, at least in the short term, which would give you an opportunity to take a profit. Alternatively, when the market is bearish, a new listing may not fair well. Your odds of success are even less with smaller, more speculative companies, or ‘penny’ stocks, that trade below $1.00, as many can trade below their issue price for years, and some may never recover. If you buy these small companies in the hope of making stag profits, the chances that you will get to hold onto the profit is low, and not just because of the likelihood of picking a good one. This comes back to ego and human psychology.

Most investors don’t know how to sell stocks, let alone fast moving ones, and when a stock rises strongly, the untrained think about how much more they could make if they hold, and not how to manage their risk and preserve profit. This is why most lose in the share market. Due to this lack of knowledge and discipline, their ability to make decisions is likely to be based on emotional and not logical reasoning. The problem with human psychology in the share market is that without rules around how to buy and sell you are more likely to be handing your money over to someone who has them.

Small company floats whose business is based on what I would call controversial products or services, are more likely to receive media attention, increasing the chances of stag profits post the float. The media attention attracts more investors and can lead to greater demand post float, at least temporarily, but doesn’t guarantee you a profit. However, it can mean that the roller coaster ride post float is more dramatic, which most investors and inexperienced traders are unprepared for.

An example of one company that had a golden debut is the small controversial float that listed on 22nd January called Phytotech Medical (PYL), a medical marijuana company. The float received a lot of media attention because of the debate that rages about the use of medical marijuana and growing commercial crops in Australia. PYL is targeting the US, Canada, Israel, and Europe and believes the industry is worth US$100 billion. PYL grabbed the attention of people who either support the concept, or saw the float as something novel to invest in. However, without proper due diligence, which is difficult with a float, and no risk management plan, you may be making a charitable donation rather than a profit.

Those in the know, who speculate on floats, such as the controversial ones because of the marketing hype, may increase their chances of a quick gain. When the stock starts trading they know that uneducated investors will try to hold for the highest price, whereas these traders plan to take profits immediately after the float, which often leads to a dramatic fall and in many cases the price may not recover at all. In the case of PYL, it has faired well, even after the sell-off. The stock cost investors $0.20 per share and within two days the price traded to around $0.92 (as shown on the daily chart below), or a profit of around 360 per cent. However, since then the stock has dropped back to around $0.255 before rising to around $0.38 at the time of writing.

Phytotech_Medical_Limited

If you punted on the float and sold during the first few days of trade you will have a great profit. Investors, still sitting on a great return, could lose it if the stock drops below $0.325. Whereas, a rise above $0.43 would indicate that further gains are likely. Not every float looks like this one, so if you attempt to trade floats and ignore the high risk warning, then be prepared to deal with the consequences and the risk to your capital. Remember that in all likelihood, the higher the potential return with any investment, the greater your risk. So at least do your research and understand what could occur. I could just leave the discussion here, however with human psychology being what it is, you may just ignore the risks. So, if you do buy into floats make sure you have capital protection.

The key, regardless of whether you intend to trade short, medium, or long term is to have a plan and the confidence to stick with it. Learn how to create your own plan, as one size does not fit all in the share market and your plan must suit the stock or market you are trading, not to mention, your own style. Copying what someone else does may not suit you, as you may not have the same experience or risk tolerance.

That said, any trade you take, whether it be on the open market or in a float, and whether short, medium, or long term, must have a stop loss. I suggest that you set a stop loss as a percentage below your purchase price, i.e. your initial stop loss. It represents your risk for the trade, or how much you are willing to lose if it goes the wrong way. You exit if the share price trades $0.01 below the level set. Your plan must also tell you what to do if the stags are running on the day of the float. Now I don’t have the space to do this justice here, however, I will say that you do need a set of rules to cover the ‘what-ifs’ and this may mean being flexible in your thinking. You may decide to set a profit target for floats, with the idea being to take some money off the table when the level is triggered, which would have worked well with PYL. To manage the remainder you can use a trailing stop and mark this on your chart.

Remember that floats are high risk and the smaller the company the higher your risk, the higher your risk the more knowledge you need before investing. Therefore, with floats, learn how to sell or steer clear.

Janine Cox is Senior Investment Analyst at Wealth Within

www.wealthwithin.com.au