Seeking Alpha

A Long Term Buy Signal For Biotech

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About: SPDR Biotech ETF (XBI), IBB
by: Walter Zelezniak Jr
Walter Zelezniak Jr
Long/short equity, portfolio strategy, ETF investing, momentum
Summary

A long term buy signal has been registered for XBI and IBB.

The pros and cons of the long term buy signal are explained.

A comparison of XBI and IBB is explored.

Readers of my articles on how I manage my retirement assets know that I use long term monthly buy and sell signals using moving averages. Since November has to come to close I looked at various charts of ETFs and noticed that the biotechnology sector has just triggered a buy signal using a 10 month moving average crossover. This article will outline the buy signal, identify the two ETFs that I am considering, and will identify the EFT I will buy on Monday morning.

There are numerous ways to go about deciding what stocks or ETFs to buy as an investment. Many SeekingAlpha readers use fundamental analysis to make their buy and sell decisions. Consequently, many SeekingAlpha readers are long term investors. I use a different approach. My investment decisions are based on technical analysis. There are many facets of technical analysis and a facet that I have had success with is using price combined with a long term moving average. For price, a technical analyst can using the daily closing price, weekly closing price, or for the purposes of this article, the monthly closing price. A moving average is a way to smooth out the volatility of daily, weekly, or monthly closing prices. Common long term moving averages that an analyst uses are the 200 day moving average for daily prices, the 40 week moving average for weekly prices, and a 10 month moving average for monthly prices. Keep in mind that there is no specific number for the moving average. The ones that I noted are simply commonly used. A 200 day moving average is calculated by adding the prices of the last 200 days and then dividing that number by 200. This step is repeated the next day. Buy and sell signals are simple to understand. When price closes above the long term moving average, investors buy. When price closes below the long term moving average, investors sell. The underlying idea is to trade with the long term trend. When price is above the long term average the trend is considered bullish. When price is below the long term average the trend is considered bearish.

There are two things to consider when using this moving average buy/sell signal. First is that an investor will never be buying at the bottom or selling at the top. It is not designed to identify the bottom or the top of the price move. The moving average signal is simply a way to get a major part of the move. It is a way to capture 70% of the price move for example. Consideration number two is that this technique is not guaranteed to be successful. It is not uncommon to be “whipsawed.” A whipsaw occurs when a buy signal is given at the close of the month because price closed above the long term moving average. This indicates that the trend is bullish and the position should move higher for a considerable amount of time and an investor buys a position. However, for any number of reasons, the position instead declines and closes the month below the long term moving average. Followers of this long term moving average strategy would then sell their position at a loss. They have been whipsawed. It is a cost of doing business. One way to reduce the number of whipsaws is to increase the length of the moving average. For example, instead of using a 10 month moving average, use a 15 month moving average instead. An investor using a 15 month moving average would reduce the chance of being whipsawed and also reduce the chance of capturing a bigger part of the move. The reason for this is that the buy signal could come a month or two later meaning the buyer buys at a higher price. The sell signal could also come a month or two later which causes selling at a lower price. Both of these actions reduce the return on the investment.

Critics of this system say this is why technical analysis is just a bunch of nonsense. There is no specific number to use for a moving average. Investors pick and choose what to follow and they end up being whipsawed. I offer the following rebuttal. How many times has a fundamental analyst decided to buy a stock because it is a “good value” only to see the stock decline in price after a position was taken? Now the stock is even a better value right? Investing is challenging. There are no right or wrong ways to select opportunities. I just find it easier to use simple trend following technical analysis for my buy and sell decisions.

As mentioned earlier biotechnology has given a buy signal using the monthly closing price and a 10 month moving average. Let’s take a look at some charts.

Chart 1 – XBI with 10 Month Moving Average

Chart 1 shows the XBI biotechnology ETF. The blue line represents the 10 month moving average. You can see that price for the month of November has closed above its 10 month moving average. XBI closed on Friday at $93.65 while the average closing price for the last 10 months is $84.96. Consequently, there is a buy signal for XBI. The goal of the system is to take advantage of long term gains. Look at the move from 2012 to mid-2015. Look at the move from late 2016 to late 2018. Those are the gains I am trying to capture using this system. By taking advantage of a sell signal I am trying to get out of a position that is declining or even sell short.

Chart 2 – IBB with 10 Month Moving Average

Chart 2 shows the IBB biotechnology ETF. This chart shows the same long term buy signal that was very profitable from 2012 to mid-2015. The period between 2016 to present shows consolidation. Price stayed in a range. This is where trend following techniques, to include moving averages, fail to deliver. Looking at Chart 2 you can see that price closed November at $119.65 while the 10 month moving average is at $107.43. This indicates that the long term trend is now bullish. Also note that the 10 month moving average is trending higher itself. This note works for Chart 1 as well. When the moving average is trending higher that is also a great indication of a bullish trend.

As Chart 1 and chart 2 show both of the common, high volume, biotechnology ETFs have a bullish buy signal. Investors can buy shares of both. I will be buying shares of XBI. Here are the reasons I am buying XBI. A big difference between XBI and IBB are the holdings of the two ETFs.

Table 1 – Top 10 Holdings of XBI

Source: https://finance.yahoo.com/quote/XBI/holdings?p=XBI

Table 2 – Top 10 Holdings of IBB

Source: https://finance.yahoo.com/quote/ibb/holdings?p=ibb

When comparing the holdings of the two ETFs, what jumps out to me is the different amount of concentration in the top 10 holdings. XBI has 20% of its holdings concentrated in its top 10 positions. Its top position is weighted at 2.48% of its total assets. IBB takes a different approach. IBB’s top 10 holdings represent 54% of its total assets. Its top holding is almost 9% of its assets. IBB’s top 3 holdings represent more concentration than XBI’s to 10 holdings.

I like the idea of buying XBI because I am looking for diversification. I already own a couple of the bigger biotech stocks such as AMGN and GILD. Consequently, I don’t want to buy an ETF where AMGN and GILD are 15% of the ETF’s holdings. Also, an argument could be made that XBI has performed better than IBB since the two ETFs have been in existence.

Table 3 – Performance Chart of XBI, IBB, SP500 index

Table 3 shows that since both ETFs have been tracked (February 2006) XBI has gained almost 500%. XBI is represented in red, IBB in blue, and the S&P 500 in green. IBB has gained 362% since February of 2006 when the comparison started. Also note that the SP 500 index has gained just 150% since February, 2006. Explosive growth can be found in biotechnology.

In summary, XBI along with IBB, have both registered a long term buy signal using the 10 month moving average. Price has closed above the 10 month moving average for both ETFs. XBI has more diversification in its holdings compared to IBB. That is an important aspect for me. Lastly, XBI has outperformed IBB since both ETFs have been in existence. Based on those facts I will be purchasing XBI because the long term trend is moving higher. I plan to hold XBI until the monthly closing price closes below its 10 month moving average. That could be at the end of December or some time in the distant future. Only time will tell.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in XBI 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.

Additional disclosure: I also own AMGN, GILD, and SPY.