If you’ve ever felt like biotech stocks seem to start collapsing just as soon as you buy them, you’re not alone: Many investors have had the unpleasant experience of discovering a hot biotech company as it was trending upward and buying some shares, only to see its price take a significant dive more or less immediately afterward.
Don’t worry, you’re not doomed to lose money in the biotech sector. But to avoid that fate, you’ll need to understand precisely what’s going wrong.
You’re buying the news instead of selling it
If you find that biotech stocks tend to go down right after you buy them, the central reason is likely that you’re investing right after these companies experience major catalysts.
Let’s use Annovis Bio (NYSEMKT:ANVS) as an example. On May 21, it reported that in a phase 2 clinical trial, its Alzheimer’s disease drug candidate appeared to improve the cognitive functioning of patients. That news caused the stock to pop by nearly 150%, adding to a great run for the year. Then, as the market’s exuberance wore off, the stock price contracted substantially over the next few days, though it remained much higher than its pre-May 21 level, and it would later go on to grow even more.
But let’s assume that an investor bought the stock while it was surging after hearing about the company’s impressive clinical trial results. Or perhaps this hypothetical trader didn’t even hear about the trial data — what they spotted was that the stock was on an upward run, so they bought some in a bid to ride the momentum. In such a situation, their investment would start to lose value more or less immediately — potentially as much as 50% of its value in the case of Annovis.
It can be painful to sit on losses like that, so it wouldn’t be too surprising if such a trader then sold the falling stock a few days after buying it to cut their losses.
The problem is that our trader only invested in the stock after the market had largely priced in the expected value of its breakthrough. Moreover, it can take some time for Wall Street to come to a consensus about such matters, especially in the wake of major news. So, by buying Annovis right when the market was at its most bullish about it — and before there had been time for the hype to fade, allowing the stock to settle back to a more reasonable level — a bad outcome was all but guaranteed.
Buy proactively, not reactively
The solution to this problem requires a shift in mindset.
Rather than buying a biotech stock because you read some positive news that sparked a bull run, invest in it well before that news gets out. You don’t need to predict the future to do this. What you do need to do is to become more comfortable with uncertainty, and double down on diversification. Most of all, you need to plan ahead.
Let’s assume that you’d like to invest in a biotech company as a long-term portfolio holding. Take Moderna (NASDAQ:MRNA) as an example. By checking out its investor materials, you can learn what projects it has in its pipeline, and roughly when management expects to be offering updates on their progress. In Moderna’s case, the company plans to start a phase 1 trial for its vaccine candidate for cytomegalovirus, a long-term complication of COVID-19, at some point before the end of 2021.
If you think that a cytomegalovirus vaccine could be highly lucrative and impactful to Moderna’s earnings in the future, you’ll want to track the program as it develops and figure out the approximate dates when management could be expected to brief investors on it — events that might precipitate noteworthy changes in its stock price. Per its website, Moderna plans to deliver a research and development (R&D) investor presentation on Sept. 9. There’s no guarantee that the company’s presentation that day will talk about the project you’re interested in, but it’ll probably contain at least some new information that could catalyze a price movement.
The point is, if you want to financially benefit from the release of new information, you need to own the stock in advance of that date, assuming that it’s the only scheduled opportunity for such a disclosure. Most likely, the cytomegalovirus vaccine candidate news with the biggest impact will come much further down the line, when it’s in its phase 2 clinical trials.
Of course, you can’t know in advance whether an interim update will contain favorable information or whether it’ll be a doleful report about less-than-stellar results. So you’ll need to hedge your bets.
Diversify your holdings to reduce the impact of the unpredictable
If you decide to buy Moderna stock before Sept. 9, what happens if management reports that the project you’re interested in hasn’t lived up to their hopes? The stock will drop, of course — which will sting. But without taking that risk, it’s much harder to gain from the alternate scenario in which the company reports a success.
To reduce the potential negative impact of one biotech’s failures, invest in another at the same time, and make sure that your biotech holdings are only a speculative part of a larger and well-diversified portfolio. Then, one biotech company’s bad news alone won’t be able to tank your portfolio’s value. And you’ll still be exposed to the potential upsides of the other biotechs you own.
To be clear, there’s no magic to this method. Anyone can build a diversified portfolio, just like anyone can read a biotech company’s website and figure out when it might report interesting results.
The trick is to claim agency over your purchasing decisions. Even if being proactive doesn’t always lead to high returns with any specific biotech stock, it’ll be better for your portfolio overall than buying them after the chickens have already flown the coop.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/07/17/heres-why-the-biotech-stocks-you-bought-keep-going/