2 Breakout Biotechs to Watch

12/07/2011 10:25 am EST

Focus: STOCKS

Thomas Aspray

, Professional Trader & Analyst

Two small-cap biotechs have just confirmed bottom formations, setting up good buying opportunities on any pullbacks to the breakout level where risk can be better managed.

Stocks have been acting strong this week, though in early-Wednesday trading, the stock index futures are slightly lower. Since the November 25 close, the Spyder Trust (SPY) is up 8.5%, the SPDR Diamonds Trust (DIA), which tracks the Dow Industrials, is up 7.8%, and the iShares Russell 2000 Index Fund (IWM) is up 12.2%.

Though the intermediate-term technical picture for the stock market is positive, the short-term analysis suggests the rally may be running out of steam. World markets now seem to be convinced that this week’s European summit will result in a viable solution to the Eurozone debt crisis. If this is the case, some profit taking would not be surprising.

There are quite a few attractive opportunities right now, and two biotech stocks in particular broke through major resistance on Tuesday, confirming their bottom formations. Both could be good buys on a pullback to the breakout level, but in general, do not be an aggressive buyer at current levels. Now is also a good time to take some profits in a recent ETF recommendation.

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Chart Analysis: The SPDR Diamonds Trust (DIA) is holding just above the short-term downtrend, line a. On Monday, the daily Starc+ band was tested, and it is now at $123.84.

  • The October 27 highs are at $122.58 with the July highs at $127.30
  • Initial support stands at $120 with the rising 20-day exponential moving average (EMA) at $118.19
  • Major support, line b, is in the $115.50-$116 area
  • The Dow Industrials’ Advance/Decline (A/D) line acted stronger than prices on the Thanksgiving-week correction, holding well above the early-November lows
  • The A/D line has not yet exceeded the October highs and has first good support at line c

The iShares Russell 2000 Index Fund (IWM) has traded in a narrow range this week with key resistance still in the $77 area, line e. This is also the 61.8% Fibonacci retracement resistance.

  • There is initial support now at $73 with stronger support at the gap in the $70.18-$72.56 area
  • Key support stands at $66.52, which was the November 25 low
  • The Russell 2000 A/D line was weaker than prices on the last decline, as it got closer to the October lows. This is a sign of weakness
  • The A/D numbers on the rally have also been disappointing, as the A/D line has fallen short of the early-November lows and the downtrend, line f

NEXT: 2 Small-Cap Biotechs to Buy on Pullbacks

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Cerus Corporation (CERS) is a $151 million biotechnology company whose primary product acts to inactivate harmful substances in blood transfusions. On Tuesday, seven-month resistance, line a, at $3.11 was overcome.

  • Next upside targets are in the $3.80-$4.00 area
  • The relative performance, or RS analysis, completed its bottom formation in the middle of November when it moved through the resistance at line b. The breakout level was retested last week
  • On-balance volume (OBV) moved through resistance (line c) two weeks before the RS line and is acting very strong
  • Volume on Tuesday was ten times the daily average and confirmed the breakout
  • Initial support now stands in the $3.04-$2.98 area with stronger support at $2.76

Oncothyreon Inc. (ONTY) is a $348 million clinical-stage biopharmaceutical company whose products focus on cancer treatment. The resistance at $7.70, line d, was decisively overcome on Tuesday.

  • The 61.8% Fibonacci retracement from the July high at $10.61 is at $9.32. ONTY traded as high as $21.78 in 2004
  • The price action has been confirmed by the RS analysis, as it has also surpassed important resistance at line e
  • Volume was four times greater than the three-month average on Tuesday and the daily OBV is above its weighted moving average (WMA). Weekly OBV (not shown) is clearly positive
  • There is initial support at $7.75-$7.80 with further support in the $7.40-$7.50 area

What It Means: The powerful nature of the rally from the Black Friday lows seems to be losing upside momentum. A 2%-3% pullback could make the market stronger. Many stocks and ETFs are well above first good support, so the risk is high on new long positions.

The two biotech stocks should be bought on any pullback to support where risk can be well controlled. Both are small caps, and I still expect the “January Effect” to make a major impact by the end of this month.

How to Profit: For Cerus Corporation (CERS), go 50% long at $3.04 and 50% long at $2.96 with a stop at $2.72 (risk of approx. 9.3%).

For Oncothyreon Inc. (ONTY), go 50% long at $7.74 and 50% long at $7.46 with a stop at $6.84 (risk of approx. 10%).

Portfolio Update

As per the November 25 Week Ahead column:

  • Buyers should be 50% long the iShares Russell 2000 Index Fund (IWM) at $68.72 and 50% long at $66.88. Sell half that position now and use a stop at $68.82 on the remaining position
  • Buyers should be 50% long the iShares S&P SmallCap 600 Growth Index Fund (IJT) at $68.64, but the second buying level at $66.62 was not hit. Use a stop at $69.74 on the open position
  • Buyers should be 50% long the Royce Value Trust (RVT) at $11.62. Use a stop at $11.62
  • Buyers should be 50% long Volterra Semiconductor Corporation (VLTR) at $21.64. Use a stop at $22.12 on that position

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