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Trading the Biotechnical Way

The biotech sector, perhaps more than any other market subgroup, is renowned for its potential for huge single-day gains and monumental blow-ups that can obliterate a market cap in a matter of hours.

Drug trial results, rulings from the Food and Drug Administration or opinions from advisory committees can send a stock soaring or plummeting. A recent example was the 45% haircut on Tuesday in Adolor (ADLR) after it released disappointing late-stage study data .

Then there's Genta (GNTA), whose stock, already a shadow of its former self, closed Aug. 31 at $1.52.

A week later two-thirds of that's gone. The catalyst was an adverse ruling from an FDA advisory panel that voted not to recommend approval of its drug Genasense for treating a type of leukemia.

Clearly the risks can be tremendous, and the rewards can be equally so, but you don't have to rely solely on fundamentals and breaking headlines for making trading decisions.

As with other sectors, evaluating the technicals in the biotechs in order to understand the general direction of the group and individual stocks can tilt the odds in your favor.

The chart of the Amex Biotechnology index caught my eye recently when it broke out of a recent base. However, as Philip Roth, chief technical market analyst for Miller Tabak + Co. points out, the breakout came on low volume, making it "suspicious." He expects it to fail and considers a close under 650 confirmation of that failure.

Jeffrey Spotts, portfolio manager for Prophecy Asset Management, doesn't think the recent action in the group has been sector-specific.

"It's been moving with the market," he says. Since the recent lows on June 14, the S&P 500 has gained 7.2%. The Amex Biotech index climbed 4.9%, but it's up 8.1% since hitting its lows a few weeks before the S&P.

Though biotech can be difficult to game for technicians because of the wild swings, Spotts can see why institutional managers are attracted to the sector.

"It's such a huge universe and the stocks are mostly uncorrelated," he states. "It's why it's such a good sector to be both long and short at the same time."

Spotts, a technical analyst, offers a few ideas based on that methodology.

Gilead Sciences (GILD - Get Report) is a decent short with a stop near the old high of $66. He says Gilead now has a record number of institutions owning the stock, with 657 funds or managers holding stakes. That tells Spotts there isn't much more money on the sidelines.

He's also not a fan of Biogen Idec (BIIB - Get Report), and he's short the stock. Biogen has been unable to recover from the massive break in February of last year when Tysabri was pulled off the market. Additionally, he points out that short institutional readings are at a two-year low, indicating a lack of pent-up demand for the shares.

As for a bullish stock, Spotts calls Lifecell (LIFC) "one of the best looking names in the group." He says the stock is "building nicely after testing the $16 breakout back in 2005."

Lastly, Spotts recommends taking a look at the chart of Adolor as an example of the perils of investing in the space. Prior to the announcement, Spotts says the stock was "setting up nicely," however, he adds that "it's important to understand the event calendar when trading these names."

Two stocks that have caught my eye from a technical perspective are Biomarin (BMRN - Get Report) and Invitrogen (IVGN)

Biomarin, with two approved products and another that could get the green light in the first quarter of 2007, has been steadily climbing since early 2005. Wednesday's drop to the trend line came on lower-than-average volume. A tight stop should limit losses if the trendline is broken.

Invitrogen, on the other hand, looks to be headed in the opposite direction. The stock is bumping up against resistance in the form of a down trendline beginning in July 2005. It broke support at about $60 after a revenue miss and is struggling to stay above that level. A close below $58 and the stock likely finds itself at $50 before too long. A tight stop will limit the damage if the stock reverses.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86, 87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback; click here to send him an email.

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