Biotech Looks To Have Bottomed

Summary

• Biotech had a weak October.
• We seem though to have printed a daily cycle low.
• Eyeing up a possible long trade. Want to see how this week finishes.

Although the Biotech ETF (NYSEARCA:NYSEARCA:XBI) has bounced somewhat since the end of October, it still is down almost 5% since the 5th of October. This may smell of opportunity as this sector has outperformed other major indices whilst still trading below its all time highs of 2015.

Nevertheless playing this sector from the long side brings its own risks to the table. Since Donald Trump has taken over the presidency, any negative soundbites involving this sector has managed to tank biotech stocks temporarily. A similar occurrence is taking place in retail concerning Amazon's (NASDAQ:AMZN) future intentions for example. Once Amazon announces a possible new venture in a respective sector, shares of companies in that sector sell off as a result. Whether more drug pricing transparency can be achieved by Trump remains to be soon.

Bulls will claim that lobbyists will be able to keep the government out of this sector and in fairness since Trump has taken office, the bulls would be correct. However Trump seems to be like a dog with a bone with big pharma and that drug pricing is way too loose in the US. I get it. I live in Spain where drug pricing is mainly set which means, at least in this jurisdiction, the drug companies cannot set their own pricing and bring in huge profits. Technically because of how oversold the biotech sector became in recent weeks, we may have a long opportunity. Here is how I see things shaping up from a technical analysis point of view.

First off, it is key to find where the last intermediate cycle lows have formed in this sector. As I have discussed in a previous article on biotech, this sector continues to make higher highs and higher lows. Therefore all things being equal every intermediate low (they usually span around 20 to 25 weeks) should be higher than the preceding one. As we can see from the chart below, the biotech sector printed intermediate lows in January, April and most recently on the 10th of August. Therefore since daily cycles (normally 3 in each intermediate cycle) usually last up to 2 months on average, there is every opportunity that biotech printed its first daily cycle low on the 26th of October @ $81.45.

With XBI currently trading at $83.90, we already have a daily swing but not the more important weekly swing. To form a weekly swing, we would have to trade above $85.81 this week which doesn't look likely since we only have Friday's session to go. However because of the length of the first daily cycle of being over 2 months, there is a high probability in my opinion that the lows of October 26th will indeed mark the lows. In any event, if we get some more evidence to the upside, we may not wait for a weekly swing and instead place a stop right below $81.45. This would mean the risk would be max $3 a share whereas the reward would be at least $8 to $10 a share as the daily cycle highs of $88.51 would certainly be taken out in this upcoming second daily cycle.

Medium term sentiment levels in popular holdings of XBI such as Gilead Sciences (NASDAQ:GILD), Biogen Inc (NASDAQ:BIIB) and Amgen, Inc.(NASDAQ:AMGN) are all at pessimistic extremes. Although not always decisive, sentiment definitely demonstrate when expectations are out of sync with how the market really is behaving. Furthermore having most of the ETF's holdings showing similar readings demonstrate that the complex may be about to turn at any time.

Source of all sentiment charts : Sentimentrader.com

Therefore we will see how today plays out before entertaining any thought of a long trade. We are mindful of our existing biotech positions so position sizing is crucial.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in XBI, LABU over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.