May 29, 2005:  We've been toying with data from biotech stocks.  If you pay attention to this group, you know that monster one day gains and losses are far more common amongst these stocks than most other stocks.  Typically, the gains come when the FDA approves a drug, and the losses come when a drug "fails" a clinical trial.  Investors often have a pretty good idea...sometimes to the day...of when the results will come out.  What they don't know is whether the results will be positive or negative.

Of course, some folks do have a fair idea about the results, whether through illegal activities, or through sheer diligence (e.g. polling doctors who are involved in clinical trials).  The question arises:  are there telltale signs in a biotech's trading activity that might help an "ordinary" investor discriminate between the two situations?

We used our software to search for biotech stocks with monstrous gains or losses over the last 12 years.  We identified 90 monstrous losers (single day losses greater than 35%) and 95 gainers (gains greater than 40%) and then looked at the trading conditions prior to these large moves.

If there's a secret, it's this:  find a stock that closed quite a bit above its low on the day prior to the big day.  Here, the opposite also applied...if the stock closed near its low, that would be an ominous sign.  In theory, a trader should still be able to take advantage of this indicator by trading in after-hours or just prior to the close.

According to the data, a strong monthlong performance prior to the "big day" predicts the big gain.  Sorting our 185 stocks according to monthlong gains, the first stock that wound up on the losing side on the big day was 24th (!) on the list (Immune Response, more than 10 years ago...the stock gained 45% in the month just prior to its big loss).  The opposite applied, but only weakly...some of the stocks with large single day gains performed quite poorly in the month prior to the big day.  There's a problem here, though:  about 5 years ago there was a period where a number of biotechs had monster gain after monster gain...these gains were more connected to investors climbing over each other's backs at the height of a bubble, than to pre-knowledge of an important announcement.  Excluding stocks from this period, large monthlong gains do not predict strong performance on the big day.

Three month or 1 year losses actually tended to predict gains, not losses.  Cheap stocks and the most volatile of stocks also fared well...it may be that investors tend to overestimate the risk versus the reward in these situations.

As is often the case, increasing or decreasing volume really didn't offer any clues.  Once again, volume appears rather over-rated as a predictor.

We also generated some charts that show the trading patterns of the typical biotech that has just taken a large single day loss.  Take a look.  Another set of charts show the trading patterns of biotechs after a large single day gain:  look here.

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