Bulkowski's Stock Offering Setup

Written and copyright © 2011 by Thomas N. Bulkowski. All rights reserved.

Stock Offering Setup: Background

I was playing with common stock offerings, trying to build a trading setup on the behavior of the event pattern. Since price drops after an offering, I researched shorting a stock and lost about $63 per trade on a $10,000 investment.

I tried going long and made only $53 per trade. Yawn.

Then I tried something new and made $2,500 per trade (on average). What's better is the setup has never failed (100% win/loss ratio)! We've struck the mother lode! Well, there is a tiny problem. It's called drawdown.

The Common Stock Offering Setup

Here's what I did. I looked at 267 common stock offerings from March 2004 to November 2009, which includes the recent bear market.

After the company prices the common stock offering, do the following.

• If the current high is more than 10% below the pre-announcement close, place a buy stop at the high price plus a penny. This is optional, but I wanted at least a 10% profit per trade.
• Trail the stop lower each day until buying in.
• Place a limit order to sell at the closing price the day before the company made its announcement.
• Cash your check at the bank. It's Miller Time!

Stock Offering Setup: An Example

That's all there is to it. The secret, is buying and holding, of course, and being willing to ride out any dips along the way.

For example, shown is a picture of Atlas Air Worldwide on the daily scale. Point D is the day price closed before the offering of common stock. It's the target price for the trade. The company announced the offering at A (but did NOT price the offering yet) and price gapped lower. They announced the PRICE of the offering at B. Many times, the announcement and pricing occur on the say day, but not in this example. Wait until they PRICE the offering.

From B onward, place a buy stop a penny above the day's high and lower it each day as the high price drops. That will get you into the stock at the opening price at C. The percentage move from C to D should be at least 10%. Otherwise, skip the trade (in other words, don't actually place a limit order until the high price is more than 10% below D. You don't have to follow this step).

Once you are into the trade, place a limit order to sell when price hits D.

That's going to take some time, so hold your nose while the stock fluctuates. In both bull and bear markets, the stocks are going to drop below the purchase price. One in my study dropped 84% before recovering. If you want to limit drawdown to 10% (think of placing a stop 10% below the buy price), then gains drop from $2500 to $560, on average. Yes, using stops are painful...

The trade shown here made 33% in 34 days.

Stock Offering Setup: Bull Market Numbers

Here's the numbers.

• I included commissions of $10 per trade ($20 round trip)
• I invested $10,000 per trade (I did not allow profits to accumulate, so each trade began with 10k).
• The average gain for bull market trades is $2,500.35 in 65 trades, or 25% per trade.
• For those trades, the average drawdown per trade was 14%, median was 10% and max was 55%
• The hold time averaged 116 days (about 4 months)

Stock Offering Setup: Bear Market Results

If including bear market results...

• The average gain is $2,697.91 (27%) in 71 trades.
• The drawdown per trade averages 17%, median is 11%, and maximum is 73%.
• The hold time average is 127 days or about 4+ months

Stock Offering Setup: Bull and Bear Market Trades

If you DON'T require a 10% minimum profit margin (the distance from C to D in the figure), for bull and bear market trades...

• The average gain is $1,387.69 (14%) in 182 trades.
• The drawdown per trade averages 11%, median is 6%, and maximum is 84%.
• The hold time average is 75 days or about 2.5 months.

-- Thomas Bulkowski

Written and copyright © 2011 by Thomas N. Bulkowski. All rights reserved. Law of gifts: You get the most of what you need the least.