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IPO Basics and Strategies

Initial Public Offerings (IPOs) represent the transition point of companies from a private status to a publicly held status.

Thus, IPOs represent one of the most closely observed events in the stock market since they mark the inception of a new trading opportunity. Since every business starts as a small enterprise, the new player on the stock market issues only a few stocks, which results in a relatively small number of stockholders.

Company Registration

The first step a company should take in order to become publicly traded includes registration with the Securities and Exchange Commission (the SEC). After this a public offering is prepared, which should include a company's prospectus and other legal documents that are required by the SEC.

Every potential investor has the right to receive a company's prospectus. The latter represents a legal and accounting document, which explains in detail the situation in the company, including information about the senior staff, majority stockowners and the potential risks the company faces.

Setting the Price of the Stock

After the company has registered with the SEC and met its other requirements, the company should contact with an investment bank(s) and sign a contract for the distribution of the shares the company is willing and able to sell. The other contractors may agree to underwrite the distribution of shares. After this both parties agree on an initial price at which the stocks to be opened for sale. This price is based on the earnings or potential earnings of the company as well as its growth. Additionally, considerations about the market's willingness to accept the agreed price should be made.

After the contracts have been signed and the price considerations made, the underwriters are ready to make the first offers to major broker clients. In turn they offer these bundles of stocks to their big retail and institutional clients. Along this chain every participant gets his/her reward.

Since the stock goes through several people until it reaches the final investors, its final price may be well above the initially set price. This is especially true if the company that issues the stock enjoys the status of being a hot deal.

As you can see individual investors suffer from such a system since at the time the stock reaches their hands, its price is significantly above the IPO level.

How to Make Money from IPOs?

Basically, you can make money by using IPOs in two ways:

  1. Buy early, sell early

    The first way in which you can benefit from an IPO is buy purchasing a stock as quickly as possible and hope that it will quickly increase its price. After this happens, sell the stock and enjoy the profits. However, this strategy is not really investing in itself. Nevertheless, if you are not too risk averse and have the time to make the necessary researches and market observations, maybe this risky strategy for making money is for you.

  2. Establish a target price

    The second strategy includes the establishment of a target price. Once the stock reaches this target price you should see whether you can purchase the stock at this price. There are cases in which the price may go up and down. So you should apply the necessary patience and wait for the stock's price to come to a reasonable level.

Finally, don't be too discouraged that it is impossible to make money from IPOs. If you apply the necessary discipline and make the needed researches you may end up with good profits. Have in mind that trading with IPOs has its risks so you should determine how far you can get.

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