How to Trade IPOs: A Beginner’s Guide to Investing in IPO Shares

Buying shares in an initial public offering (IPO) can be an exciting opportunity, but it also comes with risks and complexities. While some IPOs generate strong early returns, others struggle to maintain their offer price once trading begins. Factors such as demand, market sentiment, and company fundamentals all play a role in determining performance.

Successfully investing in IPOs requires more than enthusiasm—it involves understanding share allocation, pricing strategies, and post-listing dynamics.

Brokerage Access to IPO Shares

Gaining access to IPO shares through a brokerage account is not as simple as buying stocks on the open market. Most IPO allocations are limited, and brokerages distribute shares based on client relationships, account size, and trading history. Large investment banks like Morgan Stanley, Goldman Sachs, and JPMorgan handle most IPO underwriting and allocate shares primarily to institutional investors, high-net-worth individuals, and select retail clients who meet eligibility criteria.

Retail investors often need accounts with brokerages that have direct access to allocations. Firms like Charles Schwab, Fidelity, and TD Ameritrade occasionally offer IPO participation, but eligibility requirements vary. Some require a minimum account balance—often over $100,000—or a history of frequent trading. Others assess investor experience and risk tolerance to ensure participants understand the volatility of newly listed stocks.

Newer fintech platforms like Robinhood and SoFi have expanded retail investor access by offering IPO shares with fewer restrictions. Robinhood’s IPO Access program allows users to request shares without meeting traditional wealth thresholds. However, demand often exceeds supply, leading to partial allocations or no shares at all. Some brokerages also use tiered systems, prioritizing higher-tier clients and leaving smaller investors with limited opportunities.

Underwriting and Pricing

Investment banks play a central role in the IPO process, structuring the offering, assessing demand, and setting the share price. The process begins with due diligence, where banks analyze the company’s financials, growth prospects, and industry position. Underwriters conduct roadshows, meeting with institutional investors to gauge demand and refine the price range. If demand is high, the final offer price may be set at the upper end of the range or even increased. Weak demand can lead to a lower price or a postponed offering. Broader market conditions also influence pricing, as volatility can impact investor appetite.

Once the offer price is set, underwriters may use price stabilization strategies to manage volatility when trading begins. A common tool is the greenshoe option, which allows banks to buy additional shares if demand is strong or sell short shares to support the price if it declines post-listing. These mechanisms help maintain orderly trading and reduce sharp price swings that could undermine investor confidence.

Types of Listing Approaches

Companies going public can choose from different listing methods, each affecting pricing, regulatory compliance, and investor participation. The chosen approach influences how shares are allocated, how the stock trades on its debut, and the level of underwriting involvement.

Book Building

Book building is the most common method for pricing and allocating IPO shares, particularly in the U.S. Underwriters solicit bids from institutional investors to determine demand at various price levels, helping establish an optimal offer price.

Underwriters compile a “book” of investor bids, specifying the number of shares and the price each investor is willing to pay. The final offer price is set based on this demand, balancing proceeds raised with post-listing stability. The Securities and Exchange Commission (SEC) requires detailed disclosures in the Form S-1 registration statement, including financial statements, risk factors, and use of proceeds. Investors should analyze these filings to assess the company’s valuation and growth potential.

Direct Listing

A direct listing allows a company to go public without issuing new shares or raising capital, instead enabling existing shareholders to sell their holdings directly on an exchange. Unlike traditional IPOs, direct listings do not involve underwriters setting an offer price or allocating shares, which can lead to greater price volatility on the first trading day. The New York Stock Exchange (NYSE) and Nasdaq permit direct listings, and in 2020, the SEC approved rule changes allowing companies to raise capital through this method.

Since there is no lock-up period in a direct listing, early investors and employees can sell shares immediately, potentially increasing supply and affecting price stability. Companies opting for this approach typically have strong brand recognition and sufficient liquidity to attract buyers without underwriter support. Notable examples include Spotify (2018) and Coinbase (2021), both of which bypassed traditional IPO underwriting fees, which can range from 3% to 7% of gross proceeds. Investors should assess trading volume and market depth to gauge potential price fluctuations.

Hybrid Models

Some companies use a hybrid approach, combining elements of book building and direct listing to optimize pricing and market access. This model may involve a traditional IPO with a portion of shares allocated through book building while allowing existing shareholders to sell directly on the open market.

One example of a hybrid model is the Dutch auction, where investors submit bids at various price levels, and the final offer price is set at the highest level that clears all available shares. Google’s 2004 IPO used this method to create a more transparent pricing mechanism. Hybrid models may also include structured lock-up provisions or staggered share releases to manage post-listing volatility. Investors should review the company’s prospectus and SEC filings to understand the specific mechanics of share allocation and pricing.

Lock-Up Periods

When a company goes public, early investors, executives, and employees often face restrictions on selling their shares due to lock-up agreements. These agreements, typically lasting 90 to 180 days, prevent a sudden influx of shares from flooding the market immediately after the IPO. This limitation helps stabilize the stock price by preventing insiders from cashing out too quickly, which could signal a lack of confidence in the company’s future prospects.

The expiration of a lock-up period can impact stock performance. If a large number of restricted shares become available for sale simultaneously, downward pressure on the stock price may occur. However, if insiders hold onto their shares despite the expiration, it could reinforce investor confidence. Analysts and traders closely monitor lock-up expirations, as they can create short-term volatility and trading opportunities.

Trading on Listing Day

The first day of trading for an IPO can be highly volatile, as market participants react to the offering price, overall demand, and broader economic conditions. Institutional investors who received early allocations may take profits, while retail traders often enter the market based on initial price movements. This dynamic can lead to sharp price swings, particularly in the opening minutes when buy and sell orders are matched.

Market makers and underwriters help stabilize trading by managing order flow and, in some cases, executing stabilization strategies such as purchasing shares to prevent excessive declines. The opening price is determined through a price discovery process where buy and sell orders are aggregated to establish an equilibrium. If demand significantly exceeds supply, the stock may open well above the IPO price, leading to a strong debut. Conversely, a weak opening can indicate tepid investor interest, potentially leading to a downward trend.

Selling IPO Shares in Secondary Markets

Once an IPO stock begins trading, investors must decide when to sell their shares based on market conditions, company performance, and personal investment goals. Short-term traders often capitalize on early momentum, selling within days or weeks if the stock experiences a sharp increase. Long-term investors may hold shares for extended periods, evaluating earnings reports, competitive positioning, and industry trends before making a decision.

Liquidity and trading volume influence the ease of selling IPO shares. Stocks with high trading activity tend to have tighter bid-ask spreads, making it easier to execute trades at favorable prices. Investors should also consider post-IPO developments, such as earnings announcements, analyst coverage, and regulatory filings, which can impact stock performance. Monitoring these factors helps investors make informed decisions about when to exit their positions.