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A Prescription to Trade Biotech Stocks

In the quiet between research announcements, you can profit from speculative drug stocks.

This column was originally published on RealMoney on March 6 at 12:04 p.m. EST. It's being republished as a bonus for readers.

Biotech stocks have become a relatively safe haven in a tough market. Its emerging leaders are hitting new highs almost every day while the

S&P 500



grind toward an uncomfortable halt.

Unfortunately, we're not talking about a broad-based rally -- it's been a stock-picker's market since a huge sector move topped out in November. Former leaders








(AMGN) - Get Amgen Inc. Report

have given up a good share of their 2005 gains in recent months.

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You have to look at the mid- and small-cap biotech stocks to find the real gems right now. Many of these lesser-known companies are swimming in red ink but show great promise. Without question, these are the issues offering the best trades so far this year.

At the top of the heap stand the companies with revolutionary drugs in the market and sugar-daddy partners taking a share of the profits. Most often these outfits have few retail products, but they sit on a pipeline of innovative drugs in the later stages of the approval process.

At the other end of the spectrum lie purely speculative plays in small-caps with no products on the market. They're hand-to-mouth operations running on the goodwill of shareholders, grants and blue-chip sugar daddies. What sets them apart is a bullish story that captures the attention of speculators and Wall Street analysts.

Of course, most small-cap biotechs never deliver on their promise. In many cases their drug trials will fail or yield mediocre results. More often, competitors with greener balance sheets will address similar medical challenges with superior products. But reality doesn't stop these companies from yielding excellent trades.

It can take years for new drugs to complete the testing and approval process. In between much-anticipated news releases lie incredibly long stretches of absolute silence. Stock-board chatter, hopeful analysts and self-assured technicians step in to fill this void with their usual measures of greed and fear.

As a result, speculative biotech stocks can rise or fall for months in well-established trends. These promising rallies and brutal selloffs can be exploited with classic trading techniques. The key to success is memorizing the research announcement schedule and then avoiding them like the plague.

Of course, you can hold biotechs through key news releases, but that's pure speculation, not trading. It makes far more sense to use the blind faith of the company's true believers to take serious money out of the market. I believe this approach works better over time than trying to guess which biotechs will succeed and which will fail.

Amylin Pharmaceuticals


makes and markets the diabetes drug Byetta with

Eli Lilly

(LLY) - Get Eli Lilly and Company Report

. The stock has been a favorite trade of mine for the last year. It rose to a new high of $46 in January and then sold off into the mid-$30s. It bounced there and has recovered to $44, where it moved sideways for all of last week.

A breakout above this short-term resistance level will trigger a test of the old high. That might yield a few whipsaws, but it should eventually give way to a new uptrend. This would set the stage for a quick run to $50. Short-term traders can exit there, but you could hang on for a run through that level.



is a profitable operation, with over $1 billion in yearly revenue. The stock sold off from $88 to $60 in 2005 after a strong run. It then moved sideways for three months in a rectangle base and broke out on heavy volume last week. It's pulling back to fill the gap and test the 200-day moving average.

A trade entry between $70 and $71 looks good for a rally back to the high at $76. Longer-term positions can be held through this key level in anticipation of a move up to resistance in the low $80s. All profits should be taken at that time because the stock could reverse and start a deep correction.

Arena Pharmaceuticals

(ARNA) - Get Arena Pharmaceuticals, Inc. Report

makes a weight-loss drug that's in late testing. The stock rallied to a four-year high at $17.60 in January and pulled back. It returned to this level two times before breaking out last week. This sets up the perfect scenario for a move into the low to mid-$20s.

The best plan is to wait for a pullback to $18, but it's possible the stock won't return to that level any time soon. One alternative would be to watch for a two- to four-week consolidation pattern just below $20 and enter on a breakout above that resistance level.

Acadia Pharmaceuticals

(ACAD) - Get ACADIA Pharmaceuticals Inc. Report

, a pick in my

Daily Swing Trade

newsletter, has promising drugs for the treatment of mental disorders. It gapped up after Jim Cramer mentioned it Jan. 30 on "Mad Money" and has since been moving sideways. This pattern should eventually yield higher prices.

Note the developing triangle pattern, with resistance at $15.50 and support at $13.70. Stand aside and wait for the stock to settle into the middle of this pattern or break out and test the triangle high at $16.25. Both the quiet middle and a rally above the old high should offer good entry points for a strong run to the low $20s.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Acadia Pharmaceuticals to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

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At the time of publication, Farley was long Acadia Pharmaceuticals, although holdings can change at any time.

Alan Farley is a professional trader and author of

The Master Swing Trader

. Farley also runs a Web site called, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;

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