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Biotechs continue to lead pack

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The Biotech Index (BTK.X) continues to lead NASDAQ related stocks ad the BTK.X pounds out another 3% in mid-day trading. This morning in OptionInvestor.com's "market monitor" we thought shares of biotech Human Genome Sciences (NASDAQ:HGSI) might play catch up in the group from the $42.81 level as it tries to achieve retracement of $46.75. The stock has jumped to the $44.50 level and other stocks we've talked about like Protein Design Labs (NASDAQ:PLDI) builds on yesterday's move with an additional 3% gain to $35.12. Larger cap Biogen (NASDAQ:BGEN) just gave us an upside alert at $58.39, which is 38.2% retracement taken from $74.75 to $48.29.

Wham! Bang! Boom!

Upward trends. Remember those? Back in the 90's, they were all over the place. It was difficult to lose money by buying stocks. Upward trends lately have been short-term, but when you get one going, traders can use regression analysis to try and get an idea of how things trade going forward.

I call it the "wham, bang, boom" type of trading that is almost characterized by a sharp upward move "wham" that begins the new upward trend, then the "bang" of a pullback or lateral move to lower band of regression, then the "boom" that either finds the stock/sector/market making a continued move higher back to the top of regression, or a break of the regression channel to the downside where you can also get the "boom" and if you don't have a stop in play just below the trade, you'll get "the boom lowered on you."

Biotech Index - With regression (tied to close, 2 Std. Devs.)

I've highlighted the "Wham, Bang, Boom" scenario to try and give traders/investors a feel for what I'm looking for going forward and some tests we set forth. I want to understand what happened in the past and try to carry that forward. Regression is another tool in the traders toolbox that they can use as they carve out a path to successful trading and investing.

Right now I'd say the biotech's are in the early "wham" stage which we might expect to take a rest near 600. Our retracement (regression above, but retracement we've talked about on other charts) shows our 19.1% retracement level at 618. OK... near- term plan look to be bullish toward 600-618 for the Biotech Index (BTK.X). How could I have traded the BTK.X successfully in the last bull run? Since I feel we're in the early "wham" stage, I can study past info and I point out an "inside day" just prior to a pullback and consolidation for the "bang" stage. If I had exited on the break below that "inside day" I would have sold at $535 on 04/19. Then waited until May 14th near the close of trading and re-entered a position at the lower end of upward regression at $530 "bang" (followed with a stop just below the previous low of $521 so I didn't get "boomed"). Then on 05/16 would have gotten the first stage of "boom" to the upside on a powerful move higher that day from $528 to $572 and eventually reaching the upward end of regression 4 sessions later. A swing trader or even an investor could have entered some biotech stocks on 05/16 and used any break of regression as a reason to exit the group or monitor their biotech stocks for weakness. The "inside day" at the top on June 6th and break of that inside day to the downside on June 7th at 646 would have had a short-term trader saying "you are the weakest link. Goodbye!"

Bringing it all together!

Remember, we said regression is just another tool in the trader/investor's toolbox. What if we had used "fitted retracement" on the upward move back in May and June (actually we did and were trading the Biotech HOLDRS (BBH) in our commentary on PremierMarkets.com during that time).

Biotechnology Index - Retracement and Regression 06/06/01

Will the past present itself in the future? So far so good I'd say. The above chart (what trader's were looking at on June 6th) shows a lot of things we've tried to teach subscribers over the years. Fitted retracement used on the upward move to identify levels of support/resistance. With regression overlaid there were several things that indicated the BTK.X was near a "top." You never know for sure. They could go higher, but the "inside day" trading technique may have helped. If we hadn't have been fortunate to have such a beautiful set-up, then perhaps the mid- point of regression and break of that trend two days later was reason enough to have taken profits.

Don't forget those point/figure charts!

The vertical count and current bullish price objective for the Biotech Index (BTK.X) is $640. This was created by a "buy singal" at the $490 level on October 11th (10-point box). Recent breaking of bearish resistance trend at $510 on October 16th had the Biotech Index (BTK.X) back in an upward trend.

Biotech Index Chart - $10 box

One subscriber said "those X's and O's charts are stupid!" I'd argue it was the relative strength chart of the BTK.X vs. SPX that had us beginning to look bullish upon the group in late September (just prior to the red A on the above chart) along with the eventual buy signal and breaking of bearish resistance and the vertical count of $640 and another buy signal at $520 that has had many subscribers on the right side of things in the biotechs for a couple of weeks.

While it takes you some time to read the above, and takes me time to write it, one you get the hang of this it actually takes you about 5-minutes in "real life" to pull all this together. If a group of stocks are improving in relative strength vs. the MARKET (like the SPX) and levels of retracement begin getting broken (to the upside) and regression channels look to be forming and the point and figure chart is giving buy signals and breaking longer- term downward trends then the market is saying something.

Don't just focus on the Biotechs, but use what you may be learning in other sectors. If I'm not finding some of the bullishness characteristics that we pointed out in the Biotechs the past couple of weeks, then don't expect Biotech Index type of results. We all new going in to things that strong stocks/groups would be the eventual leaders. It's been a historical pattern that strong stocks/group lead an advance. So far, so good. Right now it looks like the biotechs are in the "wham" phase. Now we just need to look for the "bang and the boom!"

Jeff Bailey
Senior Market Technician
Option Investor

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