BIOTECH BREAKOUT -- BUYING LEADERS OR LAGGARDS -- HOW TO USE SECTOR INFORMATION

BIOTECH BREAKOUT ... Biotech stocks continue to show good chart action and good relative strength. The purpose of this market messsage is to update my August 27 piece on the biotech group, show the technical improvement since then, and also sugget a number of ways of taking advantage of this rallying sector. Chart 1 shows the AMEX Biotechnology Index breaking through its summer highs to reach the highest level in five months. There are two other important pieces of information in Chart 1. First, the BTK broke though its 200-day average a couple of weeks ago (which was pointed out on August 27). Second, the BTK/S&P ratio broke its downtrend line in mid-August and has been rising since. The ratio line goes to the heart of sector analysis. The main goal in sector trading is to find sectors or industry groups that are just starting to outperform the broader market. That's usually a combination of a rising ratio line and the breaking of the 50- and 200-day moving averages. In a declining market, that information isn't that helpful. In a market that's starting to rise, however, those are the groups that stand the best chance of outperforming the overall market. It's also important to put the short-term daily chart into proper perspective. For that reason, weekly (or monthly) charts are invaluable. Chart 2 is a weekly bar chart of the BTK Index and also holds valuable information. Notice that the BTK broke out in April of 2003 and its relative strength line surged. That was bullish sign for the biotech group. We appear to be getting a similar (but less dramatic) signal now. After holding above chart support near last October's low, the BTK is back over its 40-week average and its relative strenth line has turned up. That's a sign of longer-term absolute and relative strength. There are several ways of taking advantage of that information. One way is to buy leading biotech stocks.

Chart 1

Chart 2

BUY THE LEADERS... The first step in trading relative strength is to isolate a group that's starting to outperform the market. Biotechs certainly qualify. A second step is to find biotech stocks that are showing good chart action and their own relative strength leadership. Two candidates are charted below. Biogen IDEC is trading well above its moving average lines and has been showing good relative strength since late July. It's also one of the biggest stocks in the group. Millennium Pharmaceuticals is also showing good relative strength although its ratio line didn't bottom until mid-August. It's one of the Nasdaq's biggest percentage gainers today. If you want to buy strength, BIIB may be the better choice. If you're looking for a cheaper stock, MLNM may be better. My personal preference is to buy the leader. But that's a matter of trading style. Some people prefer to buy lagging stocks in a strong group because they're cheaper. While there's merit in that approach, history shows that current leaders tend to remain as leaders. While there's more risk in buying a leading stock, there's also more profit potential. There are two other biotech stocks that look even stronger.

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GILEAD HITS NEW RECORD... The six-month chart of Gilead Sciences shows the stock hitting a new 52-week high. It's relative stength line is doing the same. Someone might look at the daily chart, however, and see no signficance to today's new high. Here's where weekly charts come into play. The weekly bars in Chart 6 show that GILD has been in a sideways trading range since the summer of 2003. After lagging the market through the second half of 2003, its ratio line turned up this spring. The stock appears to be breaking through its 2003 to a new record high. That puts this leader on a buyer's biotech shopping list. If GILD appears to high, there's another biotech candidate that looks a lot cheaper.

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HUMAN GENOME SCIENCES BREAKS 200-DAY AVERAGE... I'm always looking for important chart developments. Here's one. The daily chart of HGSI shows the stock having just broken through its 200-day moving average and hitting a four-month high. Notice the sharp upturn in its relative strength line a month ago. That's a good combination of absolute and relative strength. Rising relative strength isn't that helpful unless the stock is also showing strong chart action. This one is. In case you're concerned that the stock looks too high to buy on the daily chart, a glance at the weekly chart should dispel that concern. The weekly bars in Chart 8 show the biotech stock just now breaking through its yearlong down trendline. Its relative strength ratio has already broken that long-term resistance line. The short and long-term chart pictures certainly qualify HGSI as a potential buying candidate. The problem with buying individual stocks in a rising sector is that there's no guarantee you'll wind up with the actual leaders. A simpler way to participate in a group rally is to buy the whole group. There are two ways to do that.

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BUYING BIOTECH ETFS ... Exchange Traded Funds (or ETFs) are baskets of stocks that trade like individual stocks on the American Stock Exchange. By using an ETF, you can buy one stock and get a piece of the entire group. Two biotech ETFs are shown below. The stronger of the two -- Biotech Holders -- is trading over its moving average lines, but is stalled at its early July peak (Chart 9). The second ETF -- Biotech iShares -- shows a rising relative strength line, but has yet to clear its 200-day line.

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OR BUY A BIOTECH MUTUAL FUND ... Another way to buy into the biotech sector is through a mutual fund. Two such sector funds are shown below -- the Fidelity Select Biotechnology and the RYDEX Biotechnology Fund. Although the Fidelity fund is the first to clear its 200-day line, the RYDEX fund is the first to break its down trendline. Both, however, show the potential for emerging as market leaders.

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TO BUY OR NOT TO BUY ... Some members have asked me to make more specific buy and sell recommendations. One reason for not doing that is because what's a buy for one type of trader might not be suitable for another. I view my job as providing guidance as to what sectors or industry groups look the most attractive at any given point in time, and then suggesting stocks in that group that have the best combination of absolute and relative strength. I try to show some leaders -- and some laggards -- so that you can choose which best suits your style of trading. You can bypass the stock selection process and use an ETF or a mutual fund as a simpler way to buy the entire group. By bringing potentially profitable ideas to your attention, I try to save you the trouble of scanning through thousands of charts for potential buys. I happen to believe that the best way to find winning stocks is to first find the winning sector. Sector trading also works better in a rising market which we now seem to be in. You can do sector filtering yourself by using the Stockchart Market Carpets. I'll explain how to do that in a future article. My job is to bring important chart developments to your attention so that you can act on them if you choose. On Tuesday, September 14, for example, I posted a bullish article on the Internet group. Chart 13 shows the IIX Internet Index finding support at its 200-day moving average line with a rising relative strength line. How you choose to use the information in my market message, however, is largely up to you.

Chart 13