Risks Run High for Biotech Companies

Aug 5, 2008: 11:26 AM CST

The broader Biotechnology iShares Index (IBB) has been showing supreme relative strength to the broader stock market, but that doesn’t mean you can buy a random biotech stock and make money – quite the opposite.  Even though the index has held up, here are two companies whose stock prices have absolutely plunged overnight, bringing immense losses to those invested in them.

First, let’s view the Biotech iShares IIndex – IBB:

The chart shows a classic example of a consolidation pattern – lengthy rectange – which has now broken upwards into a ‘realization’ phase which is exhibiting an almost perfect 45 degree angle on increased volume.  Not only has this index shown relative strength by remaining flat while the market plunged throughout May and June, but now the index is making new highs while the market is stagnating.

If you had participated in this iShare ETF recently, you would have been experiencing a smooth, comfortable appreciation in prices.  What would have happened had you tried to be savvy and ramp up gains through buying individual companies?  Let’s look at a couple of recent examples of gross underperformance and surprises through failed drug tests or announcements of new negative side effects.

Biogen Idec Inc (BIIB):

After reaching a high last week above $72, news that two new cases of a rare brain disease were found in Multiple Sclerosis patients taking its treatment Tysabri sent shares plunging instatly, taking away profits from investors who joined the up-trend late.

Company partner Elan Corporation (ELN) shared a similar fate:

Elan lost over 50% of its value recently, as investors fled for the exits upon the news.

Full news story of these newly deemed risky stocks can be found via Forbes in the article “Risks Run High for Biogen, Elan.

The point I take home is that it is (often) far safer to invest (or swing trade) in an exchange traded fund than it is to speculate or trade in individual stocks, especially in the volatile biotechnology or drug sector, where one whisper or one failed laboratory test can send the fair valuation for a given stock plunging overnight, leaving buyers trapped.

ETFs offer mitigated risks through balanced ‘portfolios’ or indexes of many companies, and while your gains may not be as high, your losses are not expected to be as high either.  Not even intelligent stop-loss placement would have saved you in this situation, though in the iShare index, the two-company plunge represented a relatively small ‘blip.’

Do be careful in individual, speculative stocks, and do consider the possible advantages of swing trading ETFs.

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