The hottest sector in the market over the last year has been the biotech stocks. Not even the market sell-offs have been able to force the sector to crack the uptrend it has been trading within over the last several years.
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That being said, the sector is in the midst of a healthy pullback that is opening up an opportunity for investors to buy at a discount. The iShares NASDAQ Biotechnology Index ETF (IBB) has pulled back six percent from an all-time high in the last two weeks.
Even with the pullback the ETF still maintains a gain of 15 percent for 2014, versus a gain of less than two percent for the S&P 500.
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What makes the pullback even more attractive is that the ETF has not breached the 50-day moving average and is holding above the previous high in the uptrend. The same pattern has occurred five times in the last year and each time the ETF rallied to hit new highs. Finally there is one more indicator on the chart that suggests the ETF will hold support and continue the uptrend the RSI indicator.
The RSI is an oscillator that helps determine when a stock is overbought or oversold based on its past price action. When the RSI moves out of oversold territory it frequently suggests the end of a pullback and is a buy signal. IBB is flashing an RSI buy signal this week as it bounces off support. This is a high probability buying opportunity for both swing traders and long-term investors.
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The pattern for the Market Vectors Biotech ETF (BBH) is nearly identical to IBB and it is also flashing an RSI buy signal this week. The two ETFs share four of the same top five holdings and should return similar results in the months ahead. One difference is that BBH has a higher concentration in its top holdings versus IBB, but it does charge a slightly lower expense ratio (0.35 percent versus 0.48 percent).
There are other ETFs in the sector that are forming similar patterns on the charts. The SPDR S&P Biotech ETF (XBI) is down seven percent from its recent high and is starting to bounce off support as it flashes an RSI buy signal. The ETF has been one of the best performers in the market this year, with a gain of 23 percent even though it has pulled back the last two weeks. The one difference between XBI and the other biotech ETFs is that it has a much more choppy pattern with deeper sell-offs and more pronounced rallies.
Historically XBI would not be as volatile, but one of its top holdings, Intercept Pharmaceuticals (ICPT) is up 561 percent this year and it has had the ETF on the move. Due to the big move this year the stock now makes up 8.3 percent of the portfolio with the number two holding only accounting for 2.8 percent. The ETF will rebalance the portfolio quarterly and the position in ICPT will be lowered to less than three percent of the total allocation.
Investors looking to enter the biotech sector now could realistically expect market-beating gains in the months ahead. However, they must also realize the magnitude of the gains may not be on the same level as they have been in the past couple of years.
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