Submitted by Joel Laceda as part of our contributors program.
IPO Hype & Social Media Madness Converge On TWTR
Trading and investing after an IPO release is a very difficult thing to do. There is no price history to lean on and you are dealing directly with the emotions of a red hot stock release.
This is momentum trading in its full glory.
There are many powerful forces at work and being on the wrong end of the trade can leave you with an investment that is bleeding money in your portfolio.
So I strongly advise the vast majority of all traders and investors leave post IPO trading to the professionals.
But if you are like most people who are naturally drawn to excitement then here is a lesson and game plan to follow for any IPO and social media trading.
Twitter Inc (NYSE:TWTR) opened on November 7, 2013 and posted a high of $50.09 and a low of $44.00 for the day. For the technical trader, the opening day proves to be an important landmark for the stock. The High and Low for the day tend to be very important prices for the stock in the future.
If you are a fundamental investor and think technical analysis is nonsensical then must I remind you that 2/3′s of all portfolio managers underperform their market index.
Why is that? It is because they fail to see that there are other factors at work other than the fundamentals that dictate the price for a stock.
The highly evolved speculator understands that they must use all the available tools to analyze a stock or ETF. There are techniques from the trader’s camp who utilize technical analysis, investors who use fundamentals and Quants who use math and patterns to determine the value for a stock or ETF.
Every technique has their strengths and weaknesses and you will find that once you study and understand how each camp thinks then you begin to see a far bigger picture and possibly a clearer road map for the stock’s trajectory.
Enough babble, let’s dig into the data from TWTR.
TWTR posted a high of $50.09 and a low of $44.00 on its first day. I noticed there was a huge seller around the $50 area disguised in the form of an Iceberg Order.
This is an order type that sits in the order book and disguises the real value of the amount it shows on the BID or OFFER. The ice berg refreshed continually around the $50.00 area and this proved to be near the high of the day.
TWTR closed at $44.90 and the reason I am telling you this is because the close price also happens to be a very important price in technical and quantitative analysis.
High = $50.09
Low = $44.00
Close = $44.90
Since this was the first day of trading for TWTR and the price action behaved in a particular manner, this suggested to me that TWTR was weak and that the path of least resistance was to the downside.
I set the $44.00-$50.09 price range as the resistance, the ‘brick wall’ for TWTR. I knew that there were a lot of sellers who were motivated to sell TWTR in that price area.
On November 14, 2013, we issued a short for TWTR @ $44.69. We also had a buy target for 1/3 of the position @ $40.27 and set a STOP @ $51.27.
Did you notice that the short entry price was in between the Low and Close of the IPO day? Just checking to see if you noticed the details.
Why use a STOP? Because it is truly the only way to enforce risk management on your trade/investment. If you don’t use stops then you are simply gambling and hoping for the best.
Do you remember how you got killed in the stock market crash of 2008/9. The main reason was that you didn’t use STOPS in your portfolio and you had to endure the pain of the entire stock market crash.
Did you know that making money in a stock market crash is much easier and quicker than in a slow bull market?
Why use a target?
It is a way to manage the overall risk on your trade/investment and it is a way to take partial profits as a stock moves in your favor.
The target is a short term goal that you should meet and it tells you if your thesis is correct. Time is a very important variable in trading, investing and in life. You need to get the direction and have good timing if you want to make money in the markets while controlling your risk.
Why 1/3 of the position as a target?
Because we want to hold onto the remainder of the position in the event that the stock goes in our favor.
Well the trade went in our favor and hit our first target @ $40.27 on November 19, 2013. Hitting our target after 3 days. That’s a 9.9% move in our favor. This is the ideal outcome. We knew our original thesis, that of lower prices, was validated when the stock plunged and hit our target quickly.
We traded on the right side of the market (the path of least resistance) and used momentum to our advantage.
I thought TWTR was done and expected a huge move to the downside. I also realized there was potential for the price to come back to the resistance/brick wall at $40.00-$44.90 – $50.09 area.
Why did I expect TWTR to get crushed?
Take a look at Facebook (NASDAQ:FB) and that’s what I used as a pseudo model for the TWTR trade.
The price was so weak in the opening months that the first bounce in June 2012 failed to reach IPO Brick wall/resistance area. The retracement stopped at the $33 area which coincides with the Fibonacci 38.2% retracement area.
Study the attached FB chart. A picture is worth a 1000 words. Huge opening IPO to the downside with additional downside acceleration. FB bounced and retested the $32.50 area (38.2% Fibonacci retracement area) then quickly plunged to the $17.50 region.
That’s a 61% move from the IPO high near $45 and a 46% move from the $32.50 resistance area. Either way it was a huge move in a very short amount of time.
That was the model for the TWTR trade. We expected a move in the 46%-61% move to the downside from the IPO High. The final target for the bottom being $19.53 – $27.05 (based on the FB model).
The TWTR and FB thesis looked very promising at the start of the trade but it didn’t turn out that way.
TWTR made a low on November 25, 2013 @ $38.80. That’s a move of 22.5% from the $50.09 high.
The lesson doesn’t end here. Click here to continue the lesson in Profit Behind The Blog. We will show you how Hedge Funds trade IPOs like FB and TWTR.