Risks of Investing in IPOs

7) Many IPO traders are in for a quick profit. Their initial buying can drive up the stock price fast, but when they start selling to take the profit (or cut a loss as the case may be) the stock price may drop equally fast.

8) Underwriters may initially support the post-IPO price so the stock will appear stable, but when the support is finally pulled, the price may decline.

9) You don't know the institutions' plans. Not every institution gets an allocation. Many will be looking to buy in the open market but unwilling to pay a high price. They may either wait for prices to settle down before establishing a position or attempt to shake retail investors out of their shares. As a result, the stock price may sag for a while but will ultimately hold up alright before advancing. If institutions are not interested, their lack of support may send a stock into a long painful decline.

10) A company may do many things to make its historic earnings look good in the IPO prospectus. The big unknown is when the company comes out with its first quarterly earnings report as a public company: will the earnings disappoint; will the IPO stock dilution hurt earnings; will the company announce special one-time charges resulting from the offering?

11) Many insiders are banned from selling for the first six months. When this lock-up period ends, they may rush to cash in their holdings, putting downward pressure on the stock. Sometimes the company will do them a favor and sell their holdings in a secondary offering, trying to place as many shares as possible with institutional investors to maintain market price stability. But institutions can sell as fast if the price moves against them.

12) The people who know the stock best - the underwriters - cannot promote it for the first 40 - 90 days. When the quiet period ends, the big unknown is what an underwriter will say about the stock. It may issue a strong buy, which will send the stock price higher, or sound lukewarm or negative, which will put downward pressure on the price. Sometimes the fact that an underwriter is not talking when it can is enough to make investors nervous. Most importantly, you don't know why an underwriter is saying what it is saying (or not saying): it may be helping its institutional clients to buy the stock on the cheap by pushing the price down temporarily or it may be helping them to sell by pushing the price up and creating the demand.