Play a Shell Game With Petri Dishes

Biotech stocks tend to be volatile. This can cause investors quite a bit of pain if they're not prepared to handle the sickening lurches and swings these stocks dish out.

That's not to say investors should avoid this sector; this volatility can yield significant profits for those who have done their homework and have a strategy for reducing positions on strength and adding to them on weakness.

I can't do the homework for you (and I can't emphasize enough how important a thorough understanding of a biotech's drug pipeline is), but my model can help with the strategy. I've used it to prepare profiles of the only five biotech stocks that have market capitalizations of $10 billion or more, which are the names you tend to see in a core portfolio of biotech stocks. Investors can capture volatility in these names by entering good-until-canceled (GTC) limit orders to buy at a value level and sell at a risky level.

But remember, my model (and any model, for that matter) does not "know" what market-moving events may be in store. Knowing a company's pipeline and what products it has up for Food and Drug Administration approval is extremely important; you should not invest in biotech until you have done your homework. Do not invest simply because of a television sound bite or any media hype.

Right now, my model suggests the sector's volatility is tilting toward raising cash by selling strength to risky levels. I don't believe this is a good time to initiate new positions in biotech stocks.

As a benchmark for biotechnology, I focus on the chart profile for the Amex Biotechnology Index (BTK), which is currently in a negative configuration. The index closed Thursday at 710.20 and has a 52-week range of 481.24 to the February high of 758.32. The weekly chart profile shows declining momentum, with the five-week MMA at 718.32. The monthly chart profile is overbought, with the five-month modified moving average at 659.74 and the September 2000 high at 811.61.

However, this negative outlook isn't affecting my decision to hold off profiling another component of biotech investing: low-priced, ultra-speculative biotech companies working on compounds that could generate enough growth to make them members of the elite $10 billion market-cap club.

To invest in this category you need to have enough risk capital to own at least five to 10 biotech companies simultaneously, because the odds of finding a home-run biotech name are only about 10%.

I can find only two companies in this speculative group that are buy-rated according to ValuEngine and at least 50% undervalued, Cerus(CERS Quote) and Xoma(XOMA Quote). I run this screen frequently, and if I find five to 10 companies that meet those two criteria, I will profile them in a subsequent column.

Playing a Select Field in Biotech Looking at core holdings in the group
Company Name (Symbol)	3/30/2006 Price	Rating	% UV/OV	Fair Value	MOM	5-Week MMA	Value Levels	Pivots	Risky Levels
Amgen (AMGN)	$72.62	BUY	0.20%	$72.50	DM	$74.30	57.63 S	66.86 S	91.57 A
Biogen Idec (BIIB)	$47.20	BUY	-6.40%	$50.45	DM	$46.84		44.47 M	48.40 W
Genentech (DNA)	$83.90	HOLD	-13.70%	$97.18	RM	$85.85	67.27 S	82.73 S/84.47 A	88.01 Q
Genzyme (GENZ)	$67.13	HOLD	-7.00%	$72.17	DM	$69.32	39.47 S	70.06 S/72.18 A	81.83 A
Gilead Sciences (GILD)	$61.67	HOLD	18.90%	$51.86	OB	$60.67	52.01 S		64.55 W
W - Weekly, M- Monthly, Q- Quarterly, S- Semiannual, A- Annual