by Thomas DeMark
For many years, I have observed a similar trading pattern for most newly issued stocks. I have been particularly sensitive to the trading activity of these new issues because I was in charge of trading these stocks when I first entered the investment business over 23 years ago. Although nothing in the investment business is for certain, and most techniques, following a period during which they work exceptionally well, undergo a period of erosion and disinterest, this method seems to have successfully withstood the rigors of various market environments and of time. Whether the climate for public offerings is hot or cold, this technique on balance seems to work, although of course, the degree of success seems to be influenced somewhat by the overall market.
Typically, once a new issue begins to trade, I look for the following characteristics regardless of the price at which the public offering is completed. Often, price will either advance or at least move sideways for a few days. The reason for this price movement is that the selling syndicate that initially offered the shares to the public for sale supports the price of the stock for a period of time. If the original offering is priced conservatively, the syndicate’s price support activity is not as critical. However, if the underwriter attempts to raise the maximum amount for the selling company, it may stretch the market to the point where prospective buyers believe it to be too expensive; price then declines. In any case, the syndicate usually is able to muster enough buying to support the offering price. In fact, I have heard of some instances in which the underwriter has insured the absence of supply by failing to compensate its broker with commissions when their clients “flipped” a new issue – bought the offering and immediately liquidated once trading began, which forced the syndicate to buy it at the syndicate bid.
Whether the stock’s price remains above the public market offering price or not, there is a tendency for price to retreat or move sideways for two to four weeks after the first two to three days of trading. Then, at about the time when most of the people originally interested in the offering become distracted, a new, more subdued surge in buying generally appears. To fine-tune the arrival of this secondary interest, I often review specific items regarding the offering. I make an effort to obtain information regarding the size of the public offering, the name of the underwriter(s), the size of the selling syndicate, the number of market makers in the stock if on NASDAQ, the amount of stock the underwriter(s) will place with investors, the volume and dollar-weighted volume for each day since the offering, and so on. This is not to say that the price activity will not conform to the one I anticipated if these items are lacking; rather, I use these criteria to market-time entries, as well as to reinforce my expectations.
Once I have found the information regarding the number of shares offered for sale, I attempt to learn how much stock the underwriter has placed in the hands of buyers. Underwriters often attempt to place the stock in strong hands – in other words, with buyers who are prepared to hold the stock for a period of time rather than liquidate once trading begins. They accomplish this by denying commissions to the broker if the stock is flipped (sold immediately) at a loss. Generally, the underwriter is obligated to support the stock at the offering price level for a period of time, and may not want to increase its inventory. Consequently, I make the assumption that the stock held by the underwriters and their customers should not be a factor in the market for a period of time. Next, I calculate the balance of stock offered by the other syndicate members. With that figure in mind, I observe the trading volume for the ensuing days. As a rule of thumb, once the syndicate members’ stock has been turned over two times, the upside move should resume.
Other items, such as the price of the stock and the exchange on which it will be listed, are incidental factors that should also be considered. Many institutions are precluded from buying a stock that does not appear on an approved list. Frequently, a stock cannot be included on the approved list if it is not priced above $10. Most reputable new issues are traded on NASDAQ, with a few exceptions that qualify for the listed exchanges. Margin requirements associated with these exchanges are important considerations as well.
Other factors, such as the lifting of the “quiet period” and the removal of major restrictions, often revitalize interest in the stock. Furthermore, a primary consideration is the subject of supply. Many investors who own a stock at a loss will sell once they break even. In the case of a recent new issue, there is no supply because there are no buyers with a loss.
The various factors I review when I consider a new issue should not be confused with the basic tendency inherent in stocks offered in new issue after-market. A noticeable pattern to advance appears three to five weeks after the offering. I suggest that, in order to be altered to potential trading candidates, you subscribe to a chart service such as O’Neill’s Daily Graphs, which monitors the daily price history of many of these stocks just after public trading begins to follow this price behavior.
New Listing on Exchange
Once the stock is listed on an exchange or added to an index, the potential for additional interest is enhanced considerably. Index funds are required to include in their portfolios all components in various indexes, and margin requirements are often more attractive once exchange listing is accomplished. For these reasons, the potential audience is often increased significantly. It is not uncommon to witness a price advance even prior to the listing, in anticipation of this tendency. Furthermore, many committees of large investment companies restrict investment to only listed stocks – and then only stocks priced in excess of $10. Because of the criteria required for listing approval, these large investors use the listing process and the active requirements to remain listed as additional safeguards to ensure that they are investing prudently. The reverse of this phenomenon occurs when a stock is de-listed. Heavy liquidation of de-listed stocks, together with prospects of the company itself failing are both legitimate concerns that are to be respected and expected.