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Tickers in this Article: XBI, IBB, XNPT, DNDN, AMGN
World stock indexes have struggled to continue the rally that began in 2009. Investors have begun to question the validity of the rally. However, there are small pockets of strength through the first two months of 2010, and the one sector that may be poised for a big year is the biotech stocks. Through February 19th, the Dow Jones US Biotech Index is up 6.1% versus a loss of 0.5% for the S&P 500. Granted this is a short timeframe to base any type of long-term investment decision on, but the last few years also indicate the biotech sector is setting up to beat the benchmarks in 2010. IN PICTURES: 20 Tools For Building Up Your Portfolio

As the S&P 500 gained over 23% in 2009, the Biotech Index was only able to manage a gain of 5%, making it one of the worst performing sectors in the US market. The yearly rotation of money can be traced back another year as the Biotech Index gained 3% in 2008 as the S&P 500 lost 38.5%. If the pattern continues, the biotech stocks should continue the early outperformance throughout the entire year.

Biotech ETFs
With approximately 160 biotech stocks trading on the major US exchanges it comes down to the stock picking abilities of investors and advisors. I have been picking stocks for years and the most difficult sector to attempt to pick a stock that will beat the market without taking on unnecessary risk is the biotech sector. This is why investors should consider investing in a biotech ETF, which is a basket of biotech stocks. The instant diversification lowers the risk dramatically as the potential reward does not fall as much. In the end, the reward-to-risk ratio becomes more attractive for the average investor either does not have the research capabilities to pick an individual biotech stock or prefers less risk. (For more, check out the Ups And Downs Of Biotechnology)

If you would like a quick example of the risk of buying an individual biotech stock, research the performance of XenoPort (NASDAQ:XNPT). In mid-February 2010, the stock lost 2/3 of its value in one trading day after releasing a statement that the FDA was delaying approval of one of their drugs. When investing in what the street calls "junior" biotech stocks, the performance often relies on one single drug approval. For obvious reasons this entails huge risk as well up huge upside potential.

There are currently five biotech ETFs that trade in the US with the two most heavily traded being the SPDR S&P Biotech ETF (NYSE:XBI) and the iShares NASDAQ Biotech ETF (NASDAQ:IBB). Even though the two ETFs track biotech indexes, they have a very different mixture of stocks that make up the portfolio and the return reflects that difference. Since the beginning of 2007, XBI has gained 24% as IBB has only added 10% for its investors. The varying returns have to do with IBB's heavy concentration of assets in their top five holdings; making up 35% of the ETF. XBI for example has less than 20% of their assets in the top five holdings.

Picking Stocks
For the investors willing to take the added risk of buying an individual biotech stock here are a few ideas to ponder.

Amgen (NASDAQ:AMGN) - One of the handful of large-cap biotech stocks available for investors, AMGN has been a bit of a laggard versus its peers lately. The stock is attractive to investors because it will not come with the extreme volatility; however, it also gives up the upside potential. With a basket of top selling drugs and more in the pipeline, the stock offers investors an avenue into the world of biotech without the single-drug risk. AMGN is the top holding of IBB, making up nearly 10% of the ETF.

Dendreon (NASDAQ:DNDN) - If volatility is the name of your game, DNDN will be more your speed. The junior biotech stock hit a high of $25.25 in 2007 before hitting a low of $2.55 in March 2009. In the eleven months since the low the stock has gained more than 10-fold and is now trading at an all-time high above $32 per share. Once again the movement of DNDN is based on the speculation of one potentially blockbuster prostate cancer drug, Provenge. The approval decision date is set for May 1st this year. If approved, Provenge could be a game changer and DNDN stock price should see a huge surge higher. If not approved the stock will likely fall dramatically. DNDN is the largest holding of XBI, making up 4% of the ETF.

The Bottom Line
When it comes down to investing in the biotech sector, the route of a biotech ETF is the best route for the majority of investors. If you do decide to pick an individual biotech stock you must be aware of the potential risk and be willing to take a big loss if the investment does not work out. The key is recognizing and managing the risk of your portfolio. (For related reading, check out Chasing Down Biotech Zombie Stocks.)

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