Should You Trade the Twitter IPO? (TWTR)

Initial public offerings, or IPOs, tend to dominate headlines any time a big-name or “story” company announces its intention to become a publically-traded company.

With the upcoming Twitter IPO rumored to reach public markets by the middle of November, traders are back on the IPO craze. Like Facebook FB, a lot of people want to get in on the Twitter IPO but is that wise?

Here’s the condensed version of how IPOs work.

A company files a form S-1 with the SEC. This form is publicly available on the SEC website. (Twitter’s form is here) The company and the banks that underwrite the IPO conduct a road show to drum up investors. Those investors will later purchase shares at an offer price. Within a few days, often the next trading day, those shares became available on the public market.

When an IPO opens to the public, the initial price, the price at the open, is often higher than the offer price. In fact, From January 1 to October 31 of last year, the initial price of the 108 IPOs during that time was an average of 17.44 percent higher than the price paid by those large investors.

But here’s the problem.

It’s not likely that you will be able to get your hands on an IPO at the offer price—especially an insanely popular IPO like Twitter. Often, your only option is to buy it in the public market after it opens.

Purchasing at the highs is what creates disaster in the accounts of retail traders around the world. The risk/reward is simply not in your favor. Buying once the IPO is an average of 17.44 percent higher doesn’t leave a lot of room for profit.

Of course, buying at the offer price is no guarantee either. Facebook was a prime example. The risk/reward, however, is much more in your favor.

And don’t discount the homework portion of the trade. You have very little information to help you size up your chances. You have no chart that provides moving averages and other technical levels, no earnings reports, and very little help from analysts. You do have the S-1 filing but even that is limited in the amount of information it discloses.

Here’s the bottom line:

If you can get your hands on shares of an IPO like Twitter at the offer price, the odds are in your favor. If you can’t, don’t be in a rush to jump into the stock. Give it some time to move past the IPO volatility craze. Once Twitter hits the market, it’s just another stock and compared to others that have a glut of information available, Twitter might be one to stick on your watch list for a while.

Disclosure: At the time of this writing, Tim Parker had no position in any of the mentioned stocks.