The Biotech sector is a very luring and intimidating corner of the market. These are companies that develop drugs and therapies for all sorts of conditions. It is a sector where you see stocks that jump 100% or more or even lose 70% of their value in a single day!
The reason for this is in a big way thanks to two factors;
- 1. Because their because market value is usually under $1 Billion and trade lower volume, though not necessarily, which can cause big movements in the price, and
- 2. Because of the incredibly enormous profitable prospects of drugs.
On this second point, in order for a company to get a drug to market, they have to pass many stages that are governed by the FDA (Food and Drug Administration) in the US and EMA (European Medicine Agency) in Europe. In order for a company to get a drug to market, they have to undergo a series of trials or stages that are regulated by these agencies before they can sell to the public. Normally there are four phases. Generally speaking;
- Phase I: Test on healthy volunteers to see how the body metabolizes the drug.
- Phase II: Sometimes split into IIa and IIb. Used to determine dosing requirements.
- Phase III: A real deal trial with many volunteers, placebos, control arm, and test arm.
- NDA Application: After they have received the ok and good results on all the previous tests they submit the data for approval. The agency can tell the company that its approved, to go back and do more testing, or even designate a priority review to Fastrack the process. Once approved a company usually has exclusive rights to sell a particular drug for many years.
Other events that can positively influence a Biotech company is a merger, acquisition, or a partnership that can enhance their profit. For example, a manufacturing partner, or a partner to distribute a proprietary drug in a new country and market. Earnings call can also have a big impact on a companies stock price because there’s potential for big news like first time profitability and any other update.
However, in the same way, that prices can be influenced to skyrocket, they too can be made to plummet by even 50% or 70% in a day if one of these events is negative. Typically there are two main reasons;
- Negative data release; For example that results from trials were not positive or significant.
- Public Offering; which is when a company sells its stock to raise money. Keep in mind that many of these biotech companies have no products in the market and getting through all the phases can take many years. Consequently, they finance their operations via things like public offerings, private investments, or grants which can affect the price negatively.
For traders, there are two main ways to play the biotech sector. The first is betting on a catalyst event and getting it right. However, with so many moving parts and phases, this can sometimes feel like a gamble, as we cannot realistically predict a consistent basis for the outcomes of these events.
The second and best way (in my opinion) is to play the run-ups to the event. Normally when there’s data release of an important potential drug or company, there will be a run-up in stock price. Regardless of the direction of the potential price jump in either direction, the anticipation is enough to drive the price.
In essence that’s the secret to playing the biotech sector profitably and consistently for the long run; Understand that playing through events is a complete gamble and its more reliable to play then 4-6 week runup. Obviously this is an oversimplification, but at least a just of the idea.
Thoughts of a psycho trader