For a short period in my career, I followed the stocks of retailers. And while I enjoyed it, it was tough to get too excited about another month of Target’s (NYSE: TGT) same-store sales number.
When you invest in Target, you want the numbers to be strong. Maybe, if you’re altruistic, you’re hoping that growing earnings will lead to more hiring and a stronger economy.
Investing in biotech is different. The financials matter, but in many cases, the companies are early stage and don’t have any products on the market yet, so revenue and earnings are nonexistent.
Some biotech investors end up investing in a company because they’re familiar with the disease the company is trying to treat. Someone whose loved one has lung cancer may discover a drug being studied for the disease and invest in the company developing it.
That person has a much stronger emotional tie to the stock than someone who hopes Target beats analysts’ estimates.
Even without such a direct connection, it’s a pretty callous person who cares about only the stock going up and doesn’t root for the drug to work in order to help patients.
As a result, investors often build emotional ties to their biotech stocks. It’s not unusual for investors to be “in love” with one of their stocks, but it’s especially common in biotech.
Who doesn’t want to see the success of a drug that helps patients with rare diseases, cancer, pediatric illnesses and many other conditions?
It’s never a good idea to let your emotions control your decision-making when it comes to investing. It’s the easiest way to lose money because you’re hesitant to sell and cut your losses even when the evidence points to the drug not working or the stock going lower.
Here are a few tips to make sure you don’t let your emotions get the best of you when investing in biotech.
You’re Not Part of the Solution
Unless you’re buying an IPO and the money is going directly to the company for research (see why I don’t like biotech IPOs here), you’re not actually helping the company forward its studies.
When you buy shares of a biotech (or any other stock) on the open market, you’re buying the shares from a third party. The money you pay goes into its pocket, not the company’s.
It’s true that you’re now a part owner of the company, but as a tiny shareholder, you will have no impact on the company’s ability to treat a disease or develop drugs.
That sounds bleak, I know, but the hope that a company will cure a dreaded disease, especially one that affects someone you care about, is a terrible reason to make an investment. You need to evaluate a company based on its merits, not on what you hope it can do for a loved one.
You wouldn’t buy shares of Target because you hope its fall apparel selection will make someone you know look good. Don’t buy a biotech stock hoping that its drug will help someone you know.
Set a Stop
At The Oxford Club, we recommend setting 25% trailing stops. That way, your loss won’t be too big if things don’t work out, especially if you follow our position sizing guidelines of never investing more than 4% of your capital in one position. And when you raise the stop as the stock rises, you can ensure you’ll get out with a profit if things reverse.
Most importantly, a stop is set without emotion. And the trade to sell is also executed without emotion. It eliminates the natural tendency to justify why you should hang on to the stock rather than sell it.
All this being said, I know of no other sector with the potential for the huge gains that biotech has. Many people have been made millionaires by owning stocks like Regeneron (Nasdaq: REGN), Celgene (Nasdaq: CELG) and AbbVie (NYSE: ABBV).
And quick explosive gains can be made in smaller biotech names. For example, last week, Viking Therapeutics (Nasdaq: VKTX) spiked 87% in one day on positive clinical trial data. Last month, Affimed (Nasdaq: AFMD) soared as much as 256% after signing a partnership agreement with Genentech.
The biotech sector can be a very lucrative place to invest. Just be sure when you’re entering a position in a biotech stock that you are doing so because you have a valid reason to expect a profit, not because you want so badly for it to succeed.