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Biotech stocks are turning bullish—here's how to profit

Biotech stocks look poised for significant upside

By Brian Shannon, CMT

Biotech stocks can be some of the riskiest stocks to have exposure to, but they can also be among the most rewarding. The way I see it, there are two types of biotech stocks. First, we have the large cap, well established companies which are represented in the Nasdaq Biotechnology Index. It includes stocks such as Amgen (AMGN), Celgene (CELG), Biogen (BIIB), Gilead (GILD), Mylan (MYL), Vertex Pharmaceuticals (VRTX) and many more.

The other type of biotech stocks are the small development stage companies whose stocks can gyrate wildly. These little biotech stocks are best left to the most speculative funds and investors who are prepared for some wild equity swings.

When it comes to biotech investing, even the large cap stocks experience high volatility, and this volatility can be dampened by trading the index. There are several biotech ETFs. The one I prefer to trade is the Nasdaq Biotechnology Index (IBB). Right now, it looks like it is time to start taking this group seriously as a sector which has longer term upside potential.

Biotech ETF (IBB) turning bullish (Source: Alphatrends.net)

From 2012 to mid-2015, the IBB ETF was an upside bull market leader. It maintained a strong rally above the 200-day moving average until late 2015, when it broke down and sellers gained control for more than a full year. There is a saying that, “If they don’t scare you out, they will wear you out.” Simply put, this means that if you are not disciplined enough to sell once the primary trend is broken, the recovery period where buyers fight to regain control will challenge most participants’ patience, and their bullish resolve will be tested to the point where they abandon their positions, possibly right at the worst time!

Looking at the sector today, you can see that the IBB is back above the 40-week (200-day) moving average and that moving average is trending higher. As the institutional saying goes, “Bulls live above the 200-day moving average and bears live below it.” When the longer-term trend begins to turn higher we have an opportunity to make large returns by following this institutional wave of optimism. As always, it’s not just a simple buy here and now strategy, a chart is a great guide to show us who is in control but it doesn’t assure that they will remain in control.

Timing the buy

For better timing of our purchase, we need to consider the trends on a shorter-term time frame. Using multiple time frames assures that we enter when we have the best chance of profits relative to the amount we are willing to risk if the market disagrees with our position. Last week the IBB pulled back slightly, and for momentum to come back into the group I will be looking to buy once the IBB clears 301. For an intermediate term trade, I am looking to place a stop just under 294, which is the low of last week and approximate location of the rising 20 day moving average.

To me, it looks like the IBB could trade up towards 345-350 over the next several months and if that happens a 7 point (2.4%) seems like a reasonable amount of risk to take relative to what might be a 15% or more winner. Always consider your own risk tolerances before getting involved and have a strategy for raising your stop if the position rallies as outlined.

Brian Shannon, CMT is the author of “Technical Analysis Using Multiple Timeframes” and the founder of www.alphatrends.net, a technical analysis based advisory service for swing traders. You can follow him on Twitter @alphatrends and on his Tumblr blog.

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