Recent IPOs Suggest a Pullback Is Near (IPO, RACE)

When retail investors have an appetite for risk many turn their attention to market segments such as commodities, technology and recently IPOs. In the article below we are going to focus on recent IPOs because the recent surge in momentum looks to have pushed prices to unjustifiably high levels based on a key technical indicator known as the relative strength index. (For a quick refresher, check out: IPO Basics: What Is An IPO?)

One of the most efficient ways for retail investors can gain exposure to new issues is to watch the Renaissance IPO ETF (IPO). As the name suggests, the fund is designed by its managers to track newly public U.S. listed companies in a portfolio, before their inclusion in core U.S. equity indexes. Fundamentally, the fund carries a total expense ratio of 0.60%, risen by more than 20% year-to-date and is comprised of 47 attractive candidates for traders willing to take on risk. With that said, based on the chart that you can see below, the fund is trading within one of the strongest uptrends found anywhere in the public markets. The bullish momentum is so strong that the recent surge has pushed the Relative Strength Index above 70, which is the common level used by traders to determine when an asset is overbought. The RSI’s prolonged reading in overbought territory, suggests that this fund could be nearing a pullback as some of the bulls start to look to lock in profit. Mean reversion theory also suggests that the fund could be headed for the support of its long-term moving averages at which point the bulls will likely look to step back in again due to more favorable risk/reward ratios.

I think at one point or another we have all dreamt of owning a Ferrari. Based on the chart of Ferrari N.V. (RACE) shown below, it appears as though investors are living their childhood dream by chasing the price of the stock higher. As discussed on the chart of the IPO ETF, the recent surge in upward momentum has sent the Relative Strength Index into overbought territory, which traders will use to suggest that a pullback toward the major support levels is likely in the cards. There is no sense in betting on a trend reversal given the strength of the uptrend, but it could prove prudent for bullish traders to wait for a move toward the long-term trendline in order to capture a more favorable risk/reward. (For more, see: IPO Basics: Getting In On An IPO).

Another fast growing company that has garnered its fair share of interest from investors is Shopify, Inc. (SHOP). In case you aren’t familiar, the company offers a cloud-based multi-channel commerce platform for small and medium-sized business. The company is growing in popularity with customers, but it has also become a darling of the investment world. Such a reputation has also helped send the Relative Strength Index above 70, which like the cases above, suggest that a pullback may be imminent.

Newly traded issues have performed well in recent months thanks in part to the insatiable risk appetitive of most investors. With that said, it looks as though it could be a good time to become more defensive as these high-risk investments trade into overbought territory based on the common Relative Strength Index. The strong move away from the long-term support levels suggests that a pullback could be looming and that the bulls may want to remain on the sidelines for a while until a better risk/reward scenario presents itself. (For more, see: IPO Basics: Don't Just Jump In).

At the time of writing, Casey Murphy did not own a position in any of the assets mentioned.