Although the S&P 500 is hitting a new all-time high today, there are certain sectors of the market that have been trending downward for weeks and remain under pressure. Biotechnology -- as seen in the biotech fund iShares Nasdaq Biotechnology (IBB) -- is probably the best current illustration of a group that is has been struggling.
Many of my biggest winners over the years have been in the biotechnology sector, so I have a bias in favor of the group, and am watching it carefully as it continues to sink. I'm convinced that some unusually good opportunities are developing but that the group may continue to languish for a while.
Many experienced traders think that bottom fishing is a suboptimal approach to trading. They want to stay focused on momentum and relative strength. The thinking is that if a stock is falling, then there is probably a good reason for the weakness.
Why fight the trend?
I have found bottom fishing to be a very effective trading style at times, because the market can be so inefficient at times. Good stocks are often mispriced for a variety of reasons that have nothing to do with their fundamentals of prospects.
By far, the easiest mistake to make is to average into a position, too big and too fast, and then to panic selling when it doesn't bounce back fairly soon. This is the mistake that causes more losses for traders than anything else.
When you bottom fish, the timing is much harder, and a primary problem is that risk management tends to go out the window when buying stocks at a low point, because the thinking is that they can't go any lower. When they do go lower than rather than admit a mistake, it is very easy to compound it by buying more.
The keys to bottom fishing are the following:
- Buy incrementally. Do not buy a full position all at once. Be ready to average up or down as things develop. It is often better to average up, but it should be based on a set strategy.
- Set a stop. If the bottom fish doesn't work, then take the stop and maybe try again. Maybe your timing was just off a little, so you can try again, but make sure you take the loss first and don't just keep adding. I will often be stopped out repeatedly, as I try to bottom fish before I actually get the timing right.
- Have a plan. Make sure you are very clear about what you plan to do. I will buy at $X price and add more at this price or take a stop at this point. Make the plan and stick with it. Most people just have some vague general plan, and then they get upset when the stock doesn't cooperate, and they react in an emotional way.
I'm quite convinced there are some great bottom fish plays developing in biotechnology. Here are some I'm watching; Myovant Sciences Ltd. (MYOV) , Personalis Inc. (PSNL) , Aurinia Pharmaceuticals Inc. (AUPH) , Ocular Therapeutix Inc. (OCUL) , Xeris Pharmaceuticals Inc. (XERS) , Allison Transmission Holdings Inc. (ALSN) , ProQR Therapeutics NV (PRQR) , etc., but if you don't approach them correctly, then you are likely to be frustrated and end up trading them poorly.