The SPDR S&P Biotech ETF (XBI) cleared 2015 resistance in the low $90s in the second quarter and has spent the summer months basing at new support. It's now testing the breakout high for the second time and could take off in a strong uptrend, underpinning rallies all across this leadership group. It's hard to pick one top component in this bullish mix, but three sector issues have rallied into price levels that could generate superior returns in the coming months. 

Slumping big caps are playing catch-up at a rapid pace, but mid caps look like the sweet spot in this equation, with many issues probing new highs. However, bid/ask spreads tend to be wide in biotech's $2 billion to $10 billion capitalization zone, with volatile intraday swings discouraging risk-averse market strategies. As a result, it's best to avoid these volatile plays if big price moves cause sleepless nights. (For a refresher on the sector, check out: A Biotech Sector Primer.)

Sage Therapeutics, Inc. (SAGE) came public at $27.00 in July 2014 and entered a choppy uptrend that accelerated in February 2015. The stock gained substantial ground in the next three months, topping out at $89.04 in June and dropping into a brutal decline that cut through the IPO opening print in March 2016. A June test at that level finally ended the downdraft, carving a double bottom reversal that marked a historic buying opportunity.

The subsequent bounce reached the 2015 high in June 2017, ahead of a December breakout that doubled the stock's price in less than two months. A shallow correction into April 2018 found support at $135, generating a mid-summer test that attracted healthy buying interest. The subsequent uptick has now reached a seven-month trendline of lower highs, with a breakout opening the door to an assault on $300. (See also: Why Biotech Sage Therapeutics May Keep Soaring.)

Charles River Labs International, Inc. (CRL) shares completed a round trip into the 2008 high at $69.19 in 2015 and broke out, entering a trend advance that gathered strength after the 2016 election. The rally topped out near $120 in November 2017, giving way to a pullback that reached support at the 200-day exponential moving average (EMA) just two weeks later. The stock tested that level repeatedly into May 2018 and turned higher, returning to resistance in June.

A July cup and handle breakout stalled at $130.66 in early August, yielding an orderly pullback that has just completed a successful test at new support and the 50-day EMA. The stage is now set for a rally back to the summer high, followed by a secondary breakout that could reach the cup and handle's measured move target above $140. In turn, that could add nearly 20 points to the most recent closing price. (For more, see: Despite Recent Volatility, Biotech Stocks Look Poised to Pop.)

Loxo Oncology, Inc. (LOXO) listed on the national exchange just above $13.00 in August 2014 and carved a sideways pattern into a June 2015 breakout that stalled at $35.00 in December. The stock spent more than a year testing support in the mid-teens, ahead of a January 2017 rally that gathered impressive momentum, lifting the stock above $200 in June 2018. A series of lower highs and lower lows pierced support at the 50-day EMA in August.

The stock remounted resistance last week, at the same time it broke out above a three-month trendline. This doubly bullish behavior predicts that the correction has come to an end, setting the stage for a rally that could test the prior high. The company will present data at three biotech conferences in September, offering potential catalysts for buying waves that could eventually reach all-time highs. (See also: 3 Stocks That May Lead a Massive Biotech Breakout.)

The Bottom Line

Mid-cap biotech stocks valued between $2 billion and $10 billion could offer healthy returns in the coming months, breaking out to all-time highs. (For additional reading, check out: How to Do Qualitative Analysis on Biotech Firms.)

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>