Trading Biotech Stocks
Making Profits in the Biotech Sector
Biotech trading is not for the faint of heart, so if you are a long-term, risk-averse investor, biotech trading is probably not for you. However, it can also be extremely lucrative, and if you are diligent about managing your stocks and stick to a few simple principles, you can minimize the risks and earn substantial profits, regardless of the overall market conditions.
The biotechnology sector is an exciting sector to follow, and it's even more exciting when you have some money in the game. But before committing your hard-earned cash into this fast-paced sector, you've got to understand how it works. It's not rocket science, but you've got to know where to find the key information and stay informed.
The following hub was put together to outline my basic strategies and principles, as well as the tools and methods I use to succeed as a biotech trader. I hope you will find it useful!
MNKD Five Year Chart
How I Got Into Biotech Trading
When I began trading stocks more than 10 years ago, I had a relatively traditional portfolio - a couple of energy stocks, a couple of technology stocks, a couple of retail stocks, and a metal (mining) company stock. Things were going pretty well (I was fortunate to buy Google in its early days), but it was moving a little too slow for my taste.
Then I was introduced to my first biotech company, Mannkind (MNKD), and I discovered the thrill, disappointment, and eventually the relatively predictable patterns of trading in the biotechnology sector. The companies in this sector live and die at the hands of the Federal Drug Administration (FDA). A biotech company's value can soar if it earns the blessing of the FDA, and its value can plummet with a thumbs down from the FDA.
That's why this sector is so volatile, but fortunately, the direction of the volatility is not impossible to predict. The FDA publishes key decision dates, and reputable biotech companies share important information to keep investors informed as they work to push their products through to FDA approval. The key to success as an trader in this sector is following the FDA calendar and timing your trades accordingly.The value of companies tend to climb as they get closer to a key FDA decision date. This pattern is called the "bio runup," and it's the foundation of biotech trading.
Please note - this hub is about trading, not investing. There is a BIG difference. For a long-term investor, the chart above probably looks like a frustrating position to hold, but for a trader, it's a potential gold mine with four chances to ride the "runup" and take profits.
Stock Market Style
Profitable in bull or bear market, high potential
Requires almost daily monitoring
Low maintenance, possible dividends
Only profitable in bull markets, less control
Trading vs. Investing
It is important to make the distinction
We need to emphasize once more that this is about trading biotech stocks, not investing in them. Generally speaking, I do not hold on to a biotech stock for more than 5-6 months, and more often than not, I hold a position for less than a month.
While investors are primarily interested in the fundamentals (equity, cash flow, price-to-earnings, etc.), traders are more concerned with the short-term movement of the stock price. Even a stock with terrible fundamentals can make some significant gains.
The action in the four-year Mannkind chart pictured above is actually pretty typical in the biotech sector, so it is important to monitor your stocks closely and be prepared to buy or sell quickly. So if you prefer to "set it and forget it," biotech trading is not your cup of tea.
OK, I will stop beating the dead horse now. I just want to be very clear about this, because it's really important, and I don't want you to get stuck with a falling stock!
What is Your Stock Market Style?
Are you an investor or a trader?
What it Looks Like (Sometimes)
A Typical Bio Runup
The chart above shows what a pretty typical "runup" looks like, although they don't always play out like this. In this example, the stock price builds as the first catalyst date approaches. In this case, the first catalyst was a briefing with an FDA panel, in which the company shared data with the FDA panel about their ongoing trial. As you can see, the price fell dramatically on the catalyst date. This was because the FDA was not impressed with the way the trial was being conducted.
After the initial disappointment from the FDA briefing, the stock began to rebound in anticipation of the second catalyst - the PDUFA date. PDUFA stands for Prescription Drug User Free Act, and this is when the FDA either gives the company approval to market its product, or rejects it and sends the company back to the drawing board for more expensive trials. This is like the Super Bowl for biotech companies. Again, the price fell dramatically, as the FDA panel did not give approval.
FDA rejections can be devastating for biotech companies, especially the smaller ones, which may have everything riding on just one or two drugs. This is why I NEVER recommend holding through the catalyst date, even when FDA approval seems like a sure thing. Sure, sometimes the company will get approval and the stock price will rise, but it is not worth the risk, and FDA decisions are never predictable. Often times, even on approval, the stock price will not rise much because investors were already expecting positive results, and therefore, the price was already inflated.
Invest in Your Education First
This book will lay out all the key information and concepts that a stock trader needs to understand. The information in this book is essential for a new trader, and can be a nice refresher for the more experienced ones.
Michael Swanson is a very experienced trader and investor. In this book, he explains how to read charts, which is an important skill in any sector of the market.
Start with an FDA Calendar
If you're seriously considering biotech trading, I suggest you start by selecting just one or two stocks. Three is OK too, but remember, you need to monitor these stocks pretty much on a daily basis, so do not go crazy, especially at the beginning.
When you're ready to find your first stock, your first stop should be the FDA calendar. There are many available online for free. I use the calendar on www.biorunup.com, but there are several other versions available for free online with the exact same information.
On the FDA calendar, you should look about six to eight months out (in the future), and identify companies that have key FDA "catalysts" coming in the near future. The catalyst are typically FDA decisions or panel reviews, and they are the events that either make or break a biotech company.
Choose Your Platform
- TD Ameritrade - A Premium Broker
TD Ameritrade is a bit expensive if you make a lot of trades, charging $9.99 per trade, but they have a lot of great tools, such as their unique ThinkorSwim (great for options traders), paperMoney, which allows you to practice trading without risking
- TradeKing - A Great Discount Broker
TradeKing has been highly rated in several reviews of discount brokers. They offer cheap trading costs ($4.95), require no minimum balance, and have a nice, professional trading platform. All things considered, this might be the best choice available
- Scottrade - Affordable and Powerful
Scottrade is positioned between discount brokers (such as TradeKing and OptionsHouse), and premium brokers (such as TD Ameritrade). They offer competitive prices ($7.00 per trade), with lots of powerful trading and banking tools and great customer se
Learn From My Big Mistake
In my early days of trading, I made a big mistake which could have been easily avoided
The third biotech stock I took a position in started off well. It was making a nice run into its catalyst and it should have been an easy profit, but I made a rookie mistake.
The catalyst was an FDA panel vote that was scheduled for the afternoon, so I thought I could just trade it in the morning before the vote. However, when I logged into my account that morning, the stock could not be traded. It had been "halted," which I later found out is a common practice on catalyst dates.
Halting a stock is meant to protect investors and traders on days when important news is expected to significantly affect the price of the stock. In my case, however, I was stuck holding through the catalyst, and therefore risking my money on the outcome of a FDA panel. Ahhhh!
As luck would have it, the FDA panel voted 13-1 against approval, and the price quickly fell by more than 50 percent. That is the kind of mistake you only need to make once to learn your lesson.
Three Rules of Biotech Trading
If you follow these three simple rules, you can greatly improve your odds of becoming a successful biotech trader.
- Don't Hold Through the Catalyst - This is the big one. Never, ever, ever hold you position through the catalyst date, regardless of the amount of good news you've read about the company, or the giant potential of its new product. Unless you just love the thrill and are willing to take on an unnecessary risk, it is never a good idea. There are countless examples of products that seemed destined for FDA approval, only to be shot down because of some unanticipated issue. Holding through the catalyst is similar to gambling on a sports event - you just never know what is going to happen.
- Don't be Greedy - If your stock has made a nice run, consider selling it and taking the profits. Sure, you might miss out on the chance to sell it at a higher price, but by not selling, you also run the risk of some unexpected event erasing all of your profits, or even sending you into the red. In this sector particularly, there are risk factors that can seem to come out of nowhere. The company might be running low on cash and issue new stock, diluting the stock on the market and decreasing the value. Or, some patients in a drug trial might suddenly develop some serious adverse reactions to the drug, and the trial must be stopped immediately to protect the patients. Recently, the R&D Director of a small biotech company left unexpectedly, and the stock prices promptly fell, because speculators thought he might know some bad news about the company. You just never know what might happen, so if you are already up, consider taking the profits and looking for your next opportunity.
- Don't be Stubborn - If you've taken a position in a stock and it just won't run like you expected it to, don't be stubborn and hold on to it thinking it will eventually turn around. Nobody - even the experts - wins every trade. If a stock price is falling, there might be a good reason for it, and you can always sell and re-enter when the price has fallen even farther. When your money is locked up in a falling stock, you not only expose yourself to the possibility of a further decline, but also miss out on all of the other opportunities out there.
Set Limit Orders to Lock in the Price You Want
Many biotech stocks are very low float stocks, meaning that there are a relatively small amount of shares available for trading. By available for trading, I mean they are not owned by some institution or corporate officer.
When there are few stocks available on the open market, the stock price can be quite volatile. Most biotech investors love these kinds of stocks, because the price can move higher very quickly. Since there are a limited number of shares available, the law of supply and demand can work heavily in your favor if he company releases some good news and more investors become interested in the stock.
But while these stocks offer some nice opportunities, traders should also account for their volatility. So, when trading low float stocks, always use limit orders. This means you agree to buy or sell the stock at a specific price, rather than just the market price. This will protect you from paying a higher price than you expected if the price suddenly moves higher. With very low float stocks, a single trade can affect the stock price.
You can set the limit order for one day, set a good till date (GTD), or set it as good till canceled (GTC). If you set it for good till canceled, make sure not to forget about it! In fact, it's usually a good idea to trade all of your stocks with limit orders to make sure you get the price you want. The only advantage of market orders is that they will be filled faster.