If you want a roller coaster ride full of ups, downs, twists, and turns, move a portion of your portfolio to the pharmaceutical or biotech sector. Every day, including weekends, news wires are full of press releases from these companies outlining the results of clinical trials conducted on new and experimental drugs and compounds.

These releases are often filled with information that the average person doesn’t understand. For example, on July 11, Celgene (NASDAQ:CELG) announced results from a Phase 3 study of its drug Revlimid, that sent the stock soaring 7 percent. Also on July 11, Bristol-Myers Squibb (NYSE:BMY) and Pfizer (NYSE:PFE) announced that the FDA accepted for review a supplemental new drug application for Eliquis, a preventative drug for pulmonary embolism. 

SEE: The Ups And Downs Of Biotechnology

What is a clinical trial, what are the various phases, and why do the results of these trials and applications often create double-digit moves in the price of the stock?

What is a Clinical Trial?
Also called an interventional study, a clinical trial involves giving participants certain drug therapies, medical devices, or behavioral changes to study its effectiveness. These trials often compare a new medical therapy to one already existing. If it’s a drug, the experimental compound is given to some patients while a placebo, an inactive compound with no medical effect, is given to others.

Clinical trials are often overseen by a medical doctor who has a support staff of other physicians and medical professionals. They’re often sponsored by a pharmaceutical company, university, private foundation, or other public and private organizations. 

What are Clinical Trial Phases?
Most biotech and pharmaceutical stories you read mention something about Phase 1, Phase 2, and Phase 3 studies but what does that mean?
In the case of drugs, the Food and Drug Administration is responsible for approving all drugs for public sale. The agency requires that all drugs follow the same path to approval.

Investigational New Drug Application (IND)
The sponsoring drug company submits this to the FDA, often after seeking the advice of the agency. The application requires that the company show results of testing done on laboratory animals and how they plan to conduct the study on humans. The FDA, along with a panel of experts called the institutional review board (IRB), then decides if it is safe to continue into the clinical trial phase. 

SEE: Pharmaceutical Sector: Does The FDA Help Or Harm?

Clinical Trial Protocols 
The IRB examines the details of the trial protocols. This includes the type of participants, schedule of testing, the medication, and dosage, the length of the study, and its objectives. Once the protocols are approved, the trials begin.

Phase 1
Phase 1 trials test for safety. The drug is given to healthy volunteers to determine the drug’s most frequent side effects and how it is absorbed and excreted. Normally, 20 to 80 people participate in phase 1 trials.

Phase 2
Does the drug work? Providing the drug is approved for further study, phase 2 is testing for effectiveness along with further safety monitoring. Does the drug have a clinically significant outcome for the condition it’s meant to treat? Participants include those with the disease or condition that the drug is indicated for. This is where some participants receive the active drug while others receive a placebo or other drug. Participants range from a few dozen to more than 300.

SEE: Evaluating Pharmaceutical Companies

Phase 3
Is it better than current treatments? The FDA and the drug’s sponsor work together to design the phase 3 studies. They might study the drug on different populations at different dosages, and in combination with other drugs. These are often double-blind studies where neither the participants nor researchers know who received the active drug. Phase 3 trials are large in scope—sometimes involving tens of thousands of people around the world but according to the FDA, most are not larger than 3,000. If the drug is found to benefit the patient more than other drugs, and the side effects are manageable, a new drug application is filed.

New Drug Application
The FDA has 60 days to decide if the application will be filed for review. If the application is incomplete, the application will be sent back to the drug sponsor. It could be something as simple as missing paperwork or as costly as not performing part of the clinical trial process.

Possible Approval
The FDA will visit the manufacturing facility, review labeling information, and study all clinical trial information to make a decision on whether to approve the drug. 

Phase 4
Phase 4 trials are sometimes conducted to study effects that emerge once the drug is approved and gains widespread use. If a side effect is reported in a significant number of patients, a phase 4 study might seek to determine if the side effect is connected to the drug or from the drug in combination with another, or certain foods.

For an infographic that describes the process, click here.

Why are Biotech and Pharmaceutical Stocks so Volatile?
The larger the company, the less unfavorable clinical data will affect its stock price but for the small startups that may be developing only one type of therapy, if it fails at any point in the clinical process, the viability of the company going forward may be in question.

According to the Pharmaceutical Research and Manufacturers of America (PhRMA), the development of a single drug could cost as much as $1.3 billion in 2005 dollars. Although there’s a wide range of price tags on drug development, what is clear is that it’s expensive. At any point in the process, the drug could be abandoned meaning that all or most of the money invested into it is gone.

According to the FDA, most drugs in development will not end up on pharmacy shelves making the process a high dollar gamble for the pharmaceutical industry.

SEE: Pharmaceutical Phenoms: America's Best-Selling Medicines

Take Action
Next time you read a press release, think about how far along a drug or device is in its development. On July 11, Alnylam Pharmaceuticals (NASDAQ:ALNY) reported positive phase 1 data on a compound it calls ALN-TTRsc. While this created double digit gains for the stock, don’t be quick to pour money into names that report early stage results.

If phase 2 or phase 3 trials don’t produce the intended results, all of the gains, plus a lot more could be erased in one day. In general, if you have a longer term perspective, look for companies that announce later stage results. These stocks are more likely to have longer-term staying power.

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