Bottom Fishing in Biotech

03/25/2011 9:46 am EST


Thomas Aspray

, Professional Trader & Analyst

The biotech sector is showing signs of resurgence and two of its top stocks may be bottoming, thus setting up potential long entries for those who like living on the edge.

The S&P Biotechnology Select Industry Group has been locked in a trading range for most of 2011, but there are signs now that it may be ready to break out to the upside. The relative performance, or RS analysis, has improved since early in March and two of the sector’s previous high-flying stocks appear to have just bottomed.

Though as of Thursday’s close, the chart patterns are compelling this is still a bottom-fishing trade and these patterns could be aborted if the stocks reverse and close sharply lower on Friday.

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Chart Analysis: Dendreon Corporation (DNDN) has had a wild ride over the past year, peaking at $57.67 last April before dropping as low as $25.78 last summer. Since the September 2010 highs, it has been in a gradual downtrend and Thursday’s strong close may be the first sign that the stock has bottomed out.

  • DNDN made its recent low of $31.31 on March 7, a week ahead of the market’s recent correction lows. On Wednesday, the low was a bit higher at $31.63, which is an encouraging sign

  • A daily close above $33.71 would be a plus, and a close above $34.92 should complete the daily bottom formation. The daily downtrend, line a, is currently in at $35.60

  • The 38.2% resistance is just above $36 with the 50% retracement resistance at $37.57. The key 61.8% resistance level and stronger chart resistance is in the $39 area

  • Volume picked up on Thursday and the on-balance volume (OBV) is testing its downtrend (line c) and is just barely above its weighted moving average (WMA). Volume was low on the recent decline.

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Savient Pharmaceuticals, Inc (SVNT) is a small-cap biotechnology company that has also been quite volatile, trading over $22 a share in October 2010 before plunging 50% after announcing it could not find a buyer.

The daily chart shows a triangle formation (lines a and b) similar to that of DNDN, but Thursday’s action was much more impressive. The shares closed up 8% after announcing a five-year contract with the US Department of Veterans Affairs to supply two of its drugs.

  • The volume on Thursday was almost double the three-month average, as the downtrend, line a, was tested. The next key resistance stands at $10.48

  • There is additional chart resistance in the $11.20-$11.60 area with the 38.2% resistance now at $14.56

  • The daily OBV has moved above its weighted moving average and the weekly OBV may follow suit after Friday’s action. A close above the OBV’s daily downtrend (line c) would be a further positive sign

  • Short-term support is now at $9.25 with further support at $9.06 and the January lows

What It Means: The biotechnology group has garnered very little interest of late and the sector certainly did not participate while the overall market was making its highs in February. The fact that the group index and many of the individual stocks appear to have bottomed before the market is also a positive sign.

How to Profit: Neither of these stocks is for the faint of heart and only a small amount of one’s overall portfolio should be committed to either one. Though the daily patterns look compelling, stronger signals from the weekly charts are needed before a bottom could be confirmed. Often, by the time that occurs, a favorable risk/reward entry becomes difficult for very volatile stocks such as these.

For DNDN, I would buy at $32.74 or better with a stop at $30.92 (risk of approx. 5.6%). Sell half the position at $35.82 and raise the stop to $31.48.

SVNT is pretty liquid, averaging 2.6 million shares traded daily, but because of the news, you may have to wait a few days to buy in at an attractive price. Go long SVNT at $9.74 or better with a stop at $8.98 (risk of approx. 7.6%). Sell half the position at $11.22 and raise the stop on the remaining position to breakeven.

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