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What Is an IPO Lockup Period and Should You Buy the Dip?

Tuesday, June 15, 2021 03:42 PM | Nick Dey
What Is an IPO Lockup Period and Should You Buy the Dip?

After an IPO, the newly minted stock often trades higher, sometimes even to to exorbitant prices during its first day of trading. Depending on the hype surrounding the company, the strength of the business, and external factors, the stock can go anywhere from there.

The early days of trading after an IPO can be a wild ride with headlines, or a lack of headlines, capable of swinging a stock up and down with ease. Investors are sensitive to news during this phase because, besides the prospectus, there is limited knowledge about the company and it’s wellbeing.

One headline that can’t harm (most) freshly IPOed stocks is insider selling. This is because insider sales are frequently prohibited during the early days of the stock’s stint as a publicly traded company through what is known as a "lockup period."

The lockup period prevents individuals who already hold shares in the company, whether it be as an early investor or as an employee of the company, from flooding the market with shares. Shareholders of the company pre-IPO tend to own a lot of shares and could be tempted to cash in shortly after the IPO if that early jump is large enough. This sudden increase in the supply of shares available to trade can push the stock lower.

The lockup period is implemented by the company as part of the marketing of the IPO to investors. This allows the market to establish a price for the stock and hopefully reward IPO investors with some profits, before the company's insiders start selling. Lockup periods aren't a legal requirement, but most investment banks insist on them before agreeing to take a company public.

The lockup period typically lasts somewhere between 90 and 180 days, though longer and shorter periods can be used.

The lockup period's end can often prove an opportunity for investors to "buy the dip" as stocks will sometimes lose some ground around that expiration date. This is partially because investors who may be sitting on gains since the IPO may trim positions before the lock up expires in anticipation of a glut of new shares pushing prices down.

Additionally, many investors see insider selling as a negative, although there is less correlation between insider sales and losses than there is between inside purchases and gains.

In any case, investors paying attention to the calendar can sometimes get shares at a steal of a price as the stock dips as markets adjust to a new float.

The lockup period allows a company to ease into the market. The company establishes an earnings history as the traders get a chance to react to some headlines and properly weight their portfolios. After a few months, shares are added to the mix as traders maintain a better understanding of the company and how it does (or doesn’t) fit in their portfolio.

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