After extremely weak performance in early 2014, the biotechnology industry understandably dropped off the radar of most investors. For those who haven’t been watching, the industry has quietly been making a comeback. For risk-tolerant investors, now could be the time to give it a second look. (For more, see: The Ups and Downs of Biotechnology.)

As you can see from the chart of the SPDR S&P Biotech Index ETF (XBI), the sector has been trading within an extremely strong uptrend since 2010. This year’s extremely wide range of $171.47 in February to the low of $118 in April is a clear example of the type of volatility that traders in this industry can expect so proceed with caution. (For more, see: The Industry Handbook: Biotechnology.)

Biotech Investing Risks

Investing in biotechnology comes with a host of risks. In most cases, these companies can live or die based on results of drug trials. As investors in Dendreon Corp. (DNDN) are painfully aware, one day you can be on top of the world, and the next you can see your investment halved — or worse. The 10-year weekly chart (below) is a clear example of how important timing can be. Investment experience, risk tolerance and capital protection are key when it comes to investing in biotechnology, and it can be extremely costly for those who venture in unaware of the risk. (For more, see: A Primer on the Biotech Sector.)

Key Players In Biotechnology

Traders who want to invest in biotech companies directly but don’t know where to start should consider checking out the top holdings of the SPDR S&P Biotech ETF. The top-five holdings are shown in the table below:

Company

Weighting (%)

Puma Biotechnology Inc. (PBYI)

5.31

InterMune Inc. (ITMN)

2.00

Anacor Pharmaceuticals Inc. (ANAC)

1.72

Exact Sciences Corp. (EXAS)

1.62

Gilead Sciences Inc. (GILD)

1.61

Source: SPDRS.com

As discussed above, biotech companies generally live or die based on trial results. There is no better example of this so far in 2014 than Puma Biotechnology, which shot up 295% on July 23 when the company announced news from a Phase III trial of its experimental breast cancer drug. This type of move can turn investors such as Alan Auerbach, the company’s founder, into a billionaire overnight. It's the type of move that most biotech investors dream of but is the exception rather than the rule. The question now for most investors is whether the company is now positioned for a buyout, which would send the stock even higher. (For related reading, see: 8 Stages of New Drug Development.)

The Bottom Line

When it comes to investing in biotechnology, it's important to understand the risk. Granted, there are few industries in which companies can go from relatively unknowns to billion-dollar enterprises overnight. This definitely has its allure, but remember that fortunes can be made and lost in a blink so be sure to tread carefully. For those who want to gain exposure to the sector, one popular tool could be the XBI ETF. For those who want to invest in specific biotechs, it may be wise to check out the components of the ETF for ideas. (For more, see: Investing In The Biotech Sector and How Gilead Became A Big Name In Biotech.)

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