The world of biotechnology stocks can be a volatile one for investors looking to play individual names.
In an environment where unexpected drug approval delays can cause major pain for any stock, detailed industry insight, knowledge of the drug approval process and a clear-cut investment strategy are essential. While a defined-risk approach is essential for any strategy, the biotech area with its daily potential for sinkholes and rocket launches calls for an extra dose of rigidity.
Given the above issues, many a non-expert in the biotech sphere might better off using one of the biotechnology exchange-traded funds as their investment vehicle of choice.
Two liquid vehicles of choice in this space for me are the iShares Nasdaq Biotechology Index Fund (NASDAQ:IBB) and the Biotech SPDR (NYSE:XBI). For purposes of this analysis, I will use the IBB in the charts that follow.
Through a longer-term lens, the iShares fund has had two mother trends. Starting in 2003, the IBB chopped back and forth in a wide trading range that ultimately did not get meaningfully broken until 2011. The second mother trend that started in 2011 led to all sorts of fireworks and saw a rally of around 70% in 26 months. Most stocks that see sharp rallies eventually must consolidate for a much-needed buyers’ exhaustion break. Given the steepness of the second mother trend, it is currently not advisable to chase this biotech ETF higher.
The daily chart below shows that the IBB is getting exceedingly close to the upper range of this steep multiyear rally. High-probability trades to the long side rarely set up at the upper end of long trading ranges, and thus investors with time horizons of at least a few months would be wise to exercise patience here and wait for prices to come down somewhere between 4% and 8% before buying/adding to positions. A 4% pullback would get the fund into the high $140s and thus closer to the middle of the uptrend for a retest of the breakout level from late February. A deeper pullback of 8% or so would get the fund back to the lower end of the channel.
In the world of technical analysis — especially when it comes to time-frames of a few months — there is lots to be said about applying the KISS (keep it simple, stupid) principle. As such, when looking at strongly trending securities, waiting patiently for mean-reversion moves is an unstressful and high-probability strategy any investor can apply.
When would a pullback no longer be a buying opportunity? In the case of the IBB, any break below the longer-term uptrend near $140 should be treated with care. While a marginal break of such levels might serve as a fake-out move, any sustained weakness around the toggle point would be the point to take final profits.