Biotechnology Sentiment At Multi-Year Extremes. What Should Investors Do?

The biotechnology sector has experienced a big rally in recent weeks. Uncoincidentally, the rally started right at major support, as seen on the first chart (lower purple line which was tested in March). The chart also shows that the first resistance line is reached (horizontal purple line), while major resistance is just 10% above today’s price (descending trendline).

Meantime, sentiment has gone through the roof. The Optimism Index for the biotechnology sector closed at 99 yesterday, a maximum reading, something it hasn’t seen in ten years, according to financial data service Sentimentrader. “Technicians are likely jumping on many of the stocks that are emerging out of a multi-month base, and big thrusts in optimism from low levels tend to lead to further increases in the weeks ahead. In biotechnology, whenever the Optimism Index jumped above 95, it rose the next day 79% of the time, then settled back over the next 2-3 days more than 65% of the time. In the weeks after that, though, it tended to lead to gains again.”

What does all this mean to investors? Combining chart patterns with sentiment data is very useful for investors. We believe that a short term top has developed. Biotechnology needs to cool off a bit, which means a retracement is the most likely outcome for the coming weeks. The key is to watch how far the retracement will go: if prices remain within the existing pattern, above support, there is an opportunity for investors to buy the dips. As long as prices remain within the current chart pattern, it is not a good idea to short this market, unless you are a very short term oriented trader.