Trade Royal Mail’s momentum potential

When Royal Mail (RMG) was privatised in October 2013 many suggested it was being sold off too cheap. Given that the hugely oversubscribed IPO price was at 330p and the stock opened up at 450p, that seemed a fair criticism at the time, especially give the healthy profits for those who were only in the shares to sell them on immediately.

Such a process is called ‘stagging’ – a speculative bet on taking a position in an IPO with the goal of selling quickly into the froth of the market hype. This was a popular pastime in the 1980s, when a spate of companies saw their shares soar after going on sale to the public, such as BT, British Gas, and even BP. The same accusations were rife then, and it is worth considering what makes an IPO success.

The owners of the company wish for the price to be set as high as possible. This minimises dilution and, for any selling shareholders, increases the proceeds raised from a sale. But here’s the dilemma: price the issue too high, and demand may be weak, and there may not be much volume in the secondary market, which could lead to a price fall. But price the issue too cheaply and it’s clear that there was a lot of money left on the table.

But a vibrant secondary market can provide healthy support to the share price and give the stock a boost in its opening few sessions. It doesn’t look good if a stock is deemed soft at the start – nobody gets excited by falling prices (apart from shorters).

One of my main gripes in the retail market is when a retail offering is ‘significantly oversubscribed’. This isn’t a problem in itself; as mentioned, secondary demand is important. It’s especially important when a company is reliant on a stock price to raise capital. And the issue is when a company allocates even more stock for the raise than originally planned to satisfy demand. This has an advantage of raising more cash for the company (although anyone can sell off the family silver on the cheap) but kills demand. Nobody wants to be liquidity for flippers.

A flipper is someone who takes the placing with the goal of ‘flipping’ it for a quick profit – much like stagging. At least with a significantly oversubscribed placing that is scaled back, it creates an incentive for buyers to bid the price up in order to get their desired allocation. But with many brokers charging commission based on the monetary amount raised, it is a classic principal/agent problem as they are happy to raise at a lower price to increase their own fees, but this is not in the interests of current shareholders.

Looking at Chart 1, we can see Royal Mail came thundering out of the blocks, notching up hefty gains in its first few months. But eventually the price began to falter, and the 50-day exponential moving average (EMA, black line) that had held up the price saw a tussle and decisive fall through. I’ve drawn an arrow where we can see the rest of the 50-day EMA now as resistance, only for the stock to crumble and plumb new lows.

Jumping to May 2014, and we saw a brief resurgence that didn’t last, and eventually the stock appeared to form a bottom in October later that year. We saw the double bottom (lower arrows) two months later in December. Range traders look to buy support and sell resistance, and while this can be a successful strategy I prefer to buy strength and sell weakness. In Chart 1, I would consider Royal Mail just another equity that is undeserving of my attention and focus.

However, things appear to have changed in Chart 2. I can’t comment on the fundamentals of the company, because even if I had an opinion I would be unlikely to have an edge against the swarms of analysts covering the stock. But where I do believe traders can have an edge is by studying the chart.

The arrows I’ve drawn indicate the separate occasions where Royal Mail’s share price tested the same price action zone. Repeat tests mark the area as significant, as it is clear other technical analysts are watching the chart and getting on board at support, and selling at resistance. It could also be that shorters are opening at resistance and covering their positions at support. The breakout that we see in December 2019 that failed to hold was a clear bear signal – the rally wasn’t sustained and sure enough the price tested the support zone again. But this time the stock gapped down on bad news, recovered slightly, then sharply fell. Those who had studied the chart would have known to get out and cut their losses.

Eight months on and we’ve seen the price test the significant resistance barrier that was previously support. Another significant test is the 200-day exponential and simple moving averages (the grey and pink lines) – the price is now directly on these. For this reason, if the price can hold above these and break through the resistance, I intend to take a long position around 192p. My stop would likely be below the 200-day moving averages, as I see this as potential support for the price and it offers me a barrier of protection before I’d have to close the position. Remember – never put a stop directly on the support line, and instead think of it as a support zone with our stops out of and below the stop-loss liquidity this zone will create.