Gaming Rules For Trading Biotech Stocks

Some people like playing cards, others prefer video games; but if you are reading this article, chances are you prefer trading biotech stocks. Biotech trading for most individual investors with their personal online accounts is a game with a clear measure of success or failure in the form of cash. Being a game, there are basic rules that I follow to make sure I can keep playing – and with a little luck, end up with more tokens to play with.

Diversification

Diversification is not a novel concept to investing, but it is even more important to those who focus on biotech stock trading. Specifically, I employ a Top 10 strategy to my personal holdings, which is posted on my Biotrader Blog site. I recommend that biotech investors diversify across the following parameters: market cap, therapeutic category, and developmental stage. I generally choose emerging biotech companies ranging from about $100 million to $2.5 billion in market cap across a variety of therapeutic categories, including medical devices and diagnostics in addition to traditional drug therapy developers. In addition, I tend to choose companies with upcoming catalysts in the form of regulatory decisions or pivotal clinical trial results, which are likely to lead to marketing approvals, partnerships, and buyouts.

Watchlist

A stock watchlist is crucial to identifying timely and promising biotech investment opportunities based on trading fluctuations in this highly volatile group of stocks. This can be done easily using free services such as Yahoo! Finance by creating a portfolio of stocks you want to follow. I track my watchlists by entering a cost basis from actual purchases or the stock price at the time I start following it. I also track trading parameters such as percent change from 50 and 200-day moving averages, the 52-week range, current price & volume, average (three month) volume, and market cap. This tracking provides me with the information I need to decide which stocks I should choose for my investments at any given moment during the trading day. The concept of creating and maintaining a watchlist is based on my next rule of doing your own stock research.

Due Diligence

It is imperative that biotech investors conduct their own due diligence, rather than relying solely on stock recommendations from investment websites or analysts. These services and recommendations are excellent for generating ideas to explore further, but I never invest in any stock on the same day I discover it, no matter how promising its prospects may be. At the very least, due diligence allows one to confirm the bullish story with their ideas, and possibly discover that there is more to the story – whether good or bad.

Profit Taking

Finally, due to the highly volatile nature of emerging biotech stocks, I make it a rule to re-evaluate my positions once they reach a plus or minus 10% threshold from my cost basis. At this point, I examine whether the underlying thesis for buying the stock is still intact, and then act accordingly to reduce, add, or eliminate my position. The 10% rule is not perfect, but it has saved me from some biotech blow-ups.

Recent Examples

Shares in DepoMed (DEPO) plunged over 50% lower on Tuesday as the company released surprisingly poor results for its experimental gabapentin GR drug candidate in the treatment of nerve pain arising from shingles. Gabapentin GR did not show a statistically significant advantage over placebo for the primary outcome of pain relief in the pivotal Phase 3 trial. I was surprised by these results since this was a re-formulation of an existing, widely-used drug. The company plans to more thoroughly examine the results and will continue the development of gabapentin GR for hot flashes.

However, DepoMed highlights my biotech trading rules perfectly; as I first recommended the stock in an article on May 16, with the stock trading below $4 per share. Within this time frame, one could have taken profits of between 20-25% with the subsequent run-up in shares to over $5. Even though gabapentin GR carried a lower level of clinical risk because it was simply a re-formulation of an existing drug, the risk was still present as the company is currently unprofitable with approved drugs that do not generate a lot of revenue. One could have either closed out their position completely with at least a 20% gain or sold enough shares to cover their original invested capital while letting the profits ride to maintain a position, if desired.

DEPO 1-yr chart

On a more positive note, since I recommended Alnylam (ALNY) and Isis Pharma (ISIS) in mid-May, the shares are up over 35% and 20%, respectively. Alnylam received a large investment from Roche, sending shares of biotech companies with RNA interference technology soaring on hopes of future buyouts and collaborations. The massive gains in these two stocks represent a chance to apply my rules of profit-taking, and if one wishes to maintain a position they can simply let their profits ride.

ALNY/ISIS 1-yr comparison chart