Biotech stocks are highly volatile, and sometimes it’s hard to pick a direction over multiple days or weeks. For many short-term traders, biotechs are a no-no. However, if you’re trading biotechs stocks in the short term and spot a trend or catalyst, there could be a wealth of opportunities. For example, if you notice biotech stocks are breaking out, you might consider an ETF tracking biotech and health care stocks. Rather than picking one or a handful of names, it would be better to trade an ETF. The same is true when those stocks are breaking down.
Our community is all about trading biotech stocks, but sometimes it’s hard to find the needle in the haystack. If you’re looking to trade biotech stocks and don’t want to be bothered with finding a specific one, there are two leveraged biotech ETFs for you: Direxion Daily S&P Biotech Bull 3X Shares (LABU) and Direxion Daily S&P Biotech Bear 3X Shares (LABD). These are leveraged ETFs, so they’re highly volatile, and you should not hold these over the long term. If you get the direction right, you could take advantage of short-term trends and magnify your returns.
LABU Stock and LABD Stock Explained
LABD and LABU track the S&P Biotechnology Select Industry Index, the underlying index. LABU aims to magnify the performance of the underlying by 300%. Conversely LABD aims to amplify the inverse of the index’s performance by 300%. That means if the S&P Biotech Select Industry Index is up 1%, LABU stock would be up around 3%, while LABD stock would be down 3%. Think of the “U” in LABU as up and the “D” in LABD as down.
When you’re trading LABD or LABU, you need to stay agile and nimble because biotechs could move fast and often. Especially when you’re trading leveraged ETFs. If you’re looking to short biotechs, your best bet would be to buy LABD. This is a better play than shorting the SPDR S&P Biotech ETF (XBI), which tracks the same underlying as LABD and LABU. If you’re naked short XBI, your risk is very high because you don’t know where it could run to. In other words, you don’t want to short XBI without buying calls to hedge yourself in the event XBI skyrockets due to a catalyst.
Leveraged Biotech ETFs vs. XBI
Here’s a look at LABU vs. XBI on the 5-minute chart:
In the chart above, the candlesticks represent LABU’s movement, while the blue line represents XBI’s performance. Notice the scales on the left and right side of the chart. LABU’s scale is on the right, while XBI’s performance is on the left. When XBI is around 3.33%, LABU is up approximately 10%. That’s the power of leveraged ETFs.
Let’s take a look at LABD:
LABD is the exact opposite of LABU. If you look at the chart, XBI was up around 3%, LABD was down around 9%. Again, take note: if you could pick the right direction for the day, you could have some nice returns.
Biotech ETF Catalysts
There’s a lot that could move specific biotech stocks, such as company specific news, FDA approvals, and Phase I, II and III data releases to name a few. It could be fundamental or technical news, but there’s generally a catalyst that moves the index. A few other reasons for a major move in a biotech index could be attributed to: sector rotation, political news, changes in the tax regime, whether there will be decreased regulations or a company like Amazon entering the space.
Now, when it comes to a biotech index, a few stocks could move the entire index. Consequently, this would trickle down to LABU and LABD. For example, if one stock in the underlying announces FDA approval and doubles, this could move the index significantly, depending on the stock.
You could even combine technicals with catalysts to find trading opportunities, it all depends on your trading style. However, you should always look for a reason for a move and decide whether the index would trend higher or lower.
Why Is Biotech Trading So Volatile?
Biotech trading has the potential for huge gains, which is why this sector is so appealing. Biotech companies have the potential for explosive growth, and traders who capitalize on stock early or when prices dip can make a significant profit. However, since biotech businesses often push a single product, there’s also a significant chance of loss should that product fail. This sector is also known for small companies, and their growth is tied to the success of clinical trials and FDA approval. If either of those things fall through, a company can fail completely.
The Bottom Line
If you are looking to trade the biotech sector and want to amplify your returns, LABU and LABD could provide a wealth of opportunities. However, these are highly risky, and you should only trade these names if you have a high risk tolerance. Moreover, you should only trade these over a short period because they aren’t designed to be bought and held over long periods.
Kyle Dennis runs Kyle Dennis’ Biotech Breakouts (biotechbreakouts.com). He is an event-based trader, who prefers low-priced and small-cap biotech stocks.