Gems from the Facebook Fiasco

by Tyler Craig on August 1, 2012

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The day-by-day demise of Facebook (FB) continues to be a thorn in the side for shareholders of the social media behemoth.  Indeed, with FB falling to new lows today we can officially say that everyone who ever purchased the toxic stock is underwater.

Yet, hidden within the epic failure are a few vital trading lessons which should be imprinted in the minds of both those who have the misfortune of holding shares of FB in their portfolio as well as curious spectators viewing the debacle from afar.  Let’s review my top two:

1.  Financial ruin beckons traders lacking an exit strategy.

Those who venture into the stock market without an exit strategy in tow have climbed aboard a train speeding toward a single destination – the financial graveyard.  This final resting place boasts an innumerable host of has-been traders with a stubborn disposition and a friend called “hope” who accompanied them all the way to their death beds.  Facebook loyalists unwilling to part ways with their shares are realizing the once promising social titan is engaged in a cut throat game of limbo.  To the spectators chanting, “How low can you go?” FB continues to surprise with its ability to reach new depths.

Traders in possession of an exit strategy who bailed early when FB ran amiss have lived to fight another day.  Those still participating in the death spiral are witnessing firsthand the mercilessness of buy and hope.

2.  The IPO playground disallows the use of technical analysis.

One of the weapons of choice for short-term traders is technical analysis.  By analyzing past price action technicians contend they can better forecast the future.  Technical analysis can also be a very effective risk management tool.  Traders are able to use key support or resistance levels to assess the potential risk and reward involved in a trading opportunity.  The trouble with IPOs, of course, is their utter lack of prior price action.  Without an existing trend or price levels to trade off of, determining risk-reward degenerates to a guessing game and the purchase of an IPO becomes a mere roll of the dice.

This explains why many veteran traders opt to wait for the IPO frenzy to die down and allow the stock to establish a trend along with important support and resistance levels to serve as reference points for future trading opportunities.

If Facebook has extracted more than its fair share of greenbacks from your war chest, chalk it up as a learning experience.  Take the two aforementioned lessons to heart and modify your trading accordingly.

{ 3 comments… read them below or add one }

W at OffRoad Finance August 1, 2012 at 9:29 am

In general I agree with both points. However, one could counter the first point with diversification. If you’re diversified 10 ways, the facebook can only take you 10% of the way to financial ruin (excluding leverage of course). Buy and hope doesn’t do a damn thing for me, but the practitioners usually do diversify for than typical traders who use other forms of risk control.

The absence of technical data is a big deal, but if you know info about the pre-IPO trading and placement process you do have an (admittedly messy) price series to work with.

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Tyler Craig August 1, 2012 at 1:18 pm

W,

Appreciate the thoughts. If one were inclined to purchase at the IPO, then yes, safety would be found in diversification. Were one to position size properly they could even ride FB to the ultimate support level of zero and survive somewhat unscathed.

Fair point on the pre-IPO trading, but in the absence of any major volume or participation I’d be skeptical on any support/resistance levels that may have formed. Admittedly, I’ve never tried it though as IPOs aren’t really in my wheelhouse.

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W at OffRoad Finance August 1, 2012 at 6:37 pm

If technical analysis is limited to support and resistance, than I agree I wouldn’t trust it. But if you widen the definition of technical trading to be any sort of analysis that can be done solely using a price history, T&S tape, and book information then you might find something more effective.

If I remember the Facebook pre-IPO price sequence, the last two things to happen were JPM offered in the low 40′s, volume went to zero, JPM pulled their offer to $38 and volume rose. A pattern of decreasing price on increasing volume following a low-volume high might trigger a technical indicator or two…

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