When It Comes To Drug Stocks, Do Not Always Buy The News
When it comes to the bio-tech, pharma and therapeutic sectors, the results from drug trials and the results from FDA evaluations can make or break stocks.
On many occasions, the percentage leader and loser boards are littered with companies from these sectors that either released positive or negative results after hours.
Many of the lower-priced stocks in this sector are one-trick ponies. In other words, they are heavily committed to one particular drug or therapy. As a result, their stocks can double, triple or head to zero when unfavorable results or recommendations are announced.
For investors dabbling in these stocks, you better be prepared for the worst possible outcome when making your investment. That way, you will not be disappointed with negative results.
If a trader is committed to one form of investing, the options markets provide a way to participate on the upside, while limiting the risk to your original investment.
When it comes to big pharma, the companies are much more diversified, so their long-term performance is not tied to one or two drugs or therapies. These companies, however, can still have large moves off these announcements.
For example, Merck (NYSE: MRK) on Thursday announced results from studies evaluating MK-5172 and Mk-8742 Investigational Hepatitis C Treatments, which the Street viewed as favorable for the company.
As a result, Merck, which closed at $57.10 on Tuesday, skyrocketed to $58.56 in pre-market trading -- surpassing the former major resistance level and multi-year high at $57.65 by almost one point.
Interestingly, some investors either received an early peek at the results or were just anticipating good results, and boosted Merck shares by over two points in Tuesday's trading ($55.04 to $57.10) -- a very unusual move for this low beta stock that averages only a one point range on most trading days. It was also its heaviest volume day since February 5.
When the true liquidity entered the market at 9:30 a.m. EST, Merck never even sniffed the pre-maket high ($58.56). Instead it opened at $57.89, absorbed the institutional sellers at $58.00 and briefly traded to $58.14.
After that, it was lights out for Merck. With the momentum traders fully on board, it sharply reversed course and cascaded over one point beyond Tuesday's close ($57.10), reaching $56.90. Since making the low, Merck has stabilized and is consolidating in the lower 57's.
How can investors avoid being taken advantage of or capitalize on such events?
First of all, take into account what the issue had done the previous day. In the case of Merck, its two-point run on Wednesday was very unusual and expectations for that move to be replicated on Thursday had a very low probability.
If the news is pushing the issue near or at your long-term target, take your profits. Your target price was based on a longer-term view of the issue and should not be altered by short-term news events.
On other hand, if you want to sit tight and see how the day unfolds, pay attention to the opening price ($57.89). Since many technical and momentum traders will enter longs on the opening print, a move back below that level may trigger sell-stops or savvy shorts that are waiting to enter on the short-side on the first sign of weakness.
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