Biotech Stocks Ready Ready To Break Out

By Joey Fundora | September 07, 2010 AAA

Recently, I've noticed that several biotech stocks have been building a similar chart pattern. This is not surprising, as institutions often trade in baskets of stocks in the same sector in order to reduce exposure. Beyond that, traders will often follow a hot stock's peers looking for sympathy moves or some level of correlation.
The current pattern I have seen developing in this group is the cup and handle base. This base can often serve as a continuation base in the middle of an uptrend, but can also act as a bottoming formation. The cup and handle was introduced by William O'Neil in his book, "How to Make Money in Stocks"; the basic premise is that the cup and handle is a consolidation pattern consisting of two sections. The first is a consolidation that resembles a rounded bottom, or saucer, which is labeled the "cup". After the right-hand side of the cup forms, a stock will often pull back partially in a flag type pattern, which gives the appearance of a "handle" to the base. Once a stock clears the handle, the pattern is considered confirmed, which often leads to a continuation move higher.

IN PICTURES:

Pfizer(NYSE:
PFE) is a pretty nice example of what this base looks like in practice. While the bowl isn't necessarily a perfect half circle, the overall price action follows the pattern in spirit. After making the turn higher, PFE has been forming a flag in a tight range. This flag would be considered the handle in the formation and a successful break above $16.60 would confirm the pattern. PFE was testing this level last week, but may need a little more time before it's ready to clear it.

Source: StockCharts.com

Forest Laboratories (NYSE:FRX) is an example of a cup and handle that is already confirmed. FRX had a bearish gap that began a several-month correction in April. FRX declined steadily into June before attempting to turn back higher. After approaching the area of the April gap lower, FRX began to drift sideways. This drift would be classified as the handle in this pattern and when FRX cleared its July highs the pattern was confirmed. FRX is too extended to buy right now, especially as it approaches the top of the unfilled April gap, but it could offer a great opportunity if it pauses for a breather.

Source: StockCharts.com

Biogen Idec (Nasdaq:BIIB) is an example with a very clean looking pattern. BIIB was in a steady decline from its April highs until rounding higher into mid summer. If you look closely, there was a small double bottom in July that ended the decline. Traders should always be on alert for these setups where a smaller pattern develops in the context of a larger overall pattern as it can increase the odds of the pattern behaving properly. BIIB then made the turn higher until pausing in late July. BIIB is currently trading in a small range between $54 and $58; a move above this level would confirm the pattern.

StockCharts.com

Abbott Laboratories (NYSE:ABT) is also following a similar pattern to its peers. It declined into the summer before rounding back higher. It is currently trading in a tight range as it builds the handle for its pattern. If ABT can clear this area it would confirm the cup and handle pattern. For those looking for a target, convention follows that a cup and handle's estimated move can be measured by subtracting the top of the handle from the bottom of the base and then adding that number to the breakout area as a target. For ABT, this would project to a target near $57-$58.

Source: StockCharts.com

Bottom Line
As with all patterns in technical analysis, it's important to not get caught up in whether the pattern is picture perfect or what it is named. It's also important to remember that these patterns are not foolproof and can be hard to discern at times. More often than not, patterns do not follow their precise definition, but by paying attention to subtle clues a trader can identify the important levels to watch in these patterns and react accordingly. Each of these stocks appears to be in the midst of completing a cup and handle base, and may be poised for continuation moves higher. Because all of these stocks are in the same general sector, it's also possible that they will continue to move in unison.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

The author does not hold a position in any of the companies mentioned above at the time of this writing.

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