Biotech breaking out

Seasonality for the Biotech sector usually starts near the end of June and ends in September. While the biotech sector is not one for conservative investors, those with the risk tolerance and possessing a short termed trading mentality may be able to take advantage of a potential opportunity in the sector.

I should start off by outlining one of the philosophies that Craig and I have adhered to when managing our Equity Platform. This will apply to how I might suggest you view a trade in this sector.

1. We believe that if a sector’s stocks display extremely high volatility and a high amount of individual security risk variation…go with the ETF sector trade.
2. If the sector (at the opposite end of the spectrum) is filled with highly correlated stocks (like banks, insurance, telecoms, utilities, etc) – again, we might buy the ETF.
3. If a sector presents the opportunity to cherry-pick the better names from a large list that constructs that group (as is more often the case), we buy the individual names. For example, you may notice that energy stocks do move up or down in a somewhat correlated manner. But there are typically strong outliers from the group that might offer better opportunities in specific energy stocks. As such, we usually (not always) buy individual energy names rather than ETF’s in that sector – or at the very least buy the ETF AND some of the potential outliers we like.

I bring this up because Biotech is one of those sectors that fall into my first of the three conditions noted above. Biotech is filled with stocks usually displaying higher volatility …. and lots of risk within the individual securities . Because of that volatility and individual security risk, I prefer to focus on an ETF to play the sector. So I’ll focus on that trade today

Two highly traded ETF’s that represent the sector are the iShares Biotech ETF (IBB) and the SPDR Biotech ETF (XBI). We own the IBB in our Aggressive Platform. That strategy has performed quite well in light of its aggressive style (click here to see our recent numbers).  We’ve been legging into the biotech sector over the past month in the Aggressive Strategy.

Here is the chart for the SPDR ETF (XBI)- focusing on the S&P Biotech index. Note the very early stages of a move, with early hooks on the momentum indicators. Upside potential is big (back to the old highs) but the ETF is not showing the strength that the IBB (below) has. This ETF offers greater risk due to its lack of thrust so far, but if it does start to move – it may be the one to own.

Here is the chart for the iShares ETF (IBB)- focusing on the NASDAQ Biotech index, which we hold. The chart shows a potential MACD cross coming, and a recent stochastics hook. Its not been through as an aggressive selloff as was the XBI (above) ETF.  Clearly, the move has been greater for the IBB ETF. We look for a test of the old highs by the fall. However, the XBI (above) may be the better contrarian play, given its lagging behind the IBB ETF.

Conclusion

No matter how you slice it- the biotech sector is a risk-reward play. This ain’t like buying a value stock, folks! For investors wanting to play the less-risky of the two ETF’s noted above – all things being equal- IBB is the “sorta, kinda” lower risk play. For investors wishing to take on more risk with much more upside potential, then XBI is your play. For investors who dislike high risk sectors, I would advise avoiding the biotech play altogether.