There are plenty of great growth stocks within IBD's biotechnology industry group. Investors have heard legendary stories of stocks like Genentech running up 300% in the 1980s or Amgen rocketing 600% in the early 1990s.
When the gains look this good, what is keeping this from being the No. 1 industry group in every market cycle? Trouble is, biotech stocks have some unique risks that make them particularly volatile and often harder to trade.
In some cases, biotechs go public without having even a single product on the market, making them quite speculative investments.
The Risks Of Biotechs
The biotech industry is flush with stocks on the cutting edge of science whose aim is to eradicate disease, increase life expectancy and vastly improve quality of life. The time and resources that it takes to bring these drugs and treatments to fruition means most companies are only producing one or two drugs at a time. All your eggs are in one or two baskets.
If something goes wrong with that product, look out. The floor collapses from underneath and the stock's price plummets, sometimes never to recover. Worst of all, you can't prepare for a bad drug trial or an FDA rejection. They don't occur on a schedule like earnings reports do.
It's worth mentioning that this type of risk extends to others in the medical sector, such as the ethical drugs group, which is also subject to regulatory approval and the risks of drug trials.
How To Trade Biotech Stocks
There are a few things that investors can do to mitigate the risk of trading biotech stocks.
One way is to go with exchange traded funds, which bundle dozens of stocks in the industry and can mitigate the risk of a single stock having a meltdown.
Your two most liquid options are the SPDR S&P Biotech ETF and the iShares Biotech ETF. Investors with high conviction can even trade the double-weighted ProShares Ultra Nasdaq Biotech ETF or triple-weighted Direxion S&P Biotech Bull.
Be warned, the double- and triple-leveraged ETFs can be backbreakers, exacerbating your losses if the industry makes a steep downturn.
A second tip: smart stock selection. Start with success and choose from leading stocks with a new or revolutionary product. The biggest winners in any industry are the ones who are changing the game, and the same is true of biotechs. Focus on companies with strong sales growth.
Amgen changed patient care in chemotherapy. Syntex was the first company to submit a patent for a birth control pill. Moderna and BioNTech were huge winners in 2020 and 2021 because of Covid-19 vaccines.
Another tip on stock selection: Avoid stocks once they reach Phase 3 trials. Wall Street prefers stocks with positive Phase 2 data. In Phase 3, as the sample size increases, so does the chance of encountering dangerous side effects. Larger sample sizes can also reveal a drop in statistically meaningful positive responses.
Novo Nordisk & HilleVax Lessons
Last July, Novo Nordisk stock was acting just fine. Then the Netherlands government decided to not cover the company's Wegovy weight-loss drug under the country's basic insurance plan. The stock sold off for two days, sending it below the 50-day moving average.
On Sept. 20, results from a trial of an experimental obesity pill were disappointing. The stock fell 5.5% and continued to trend lower.
HilleVax is a small-cap biotech developing novel vaccines. The stock was forming a base this year until some bad news came out on July 8. Its experimental norovirus vaccine failed trials. The stock plummeted to $1.64, falling nearly 90% from the day prior. The stock remains around 1.75 a share.
