An Interview With Mike Messier on Catalyst Trading the Biotech Stocks
The following interview is extracted from my book, Breakthrough Strategies of Wall Street Traders. Similar to Market Wizards, within it I interview 17 remarkable traders and investors for their investing stories and unlike other investing books, get them to actually reveal the trading-investing rules and techniques they use as well as what they tried that didn't work. If you want to learn trading and investing, start with these systems.
Many investors and traders are familiar with big biotech firms like Gilead, Celgene and Amgen. However, few are familiar with names in the small-cap biotech stock arena, which is populated by little companies without income that are struggling to make ends meet. These smaller biotech companies raise capital in the hopes that their potential pharmaceutical will eventually be approved for sale by the FDA. Naturally they must update investors as to the status of their drugs in the FDA approval process.
As a result, small biotech firms periodically make announcements to update investors on how their potential drugs are faring in Phase 1, Phase 2, and Phase 3 clinical trials stipulated by the FDA. The news announcement of a drug’s status within the FDA approval process is called a “catalyst” or trigger that can propel the price of a security dramatically. The date that an announcement happens is called the catalyst date and naturally this event affects the fortunes of the stock and the company.
As a short-term trading strategy you can buy these stocks if you expect a price upswing before a major positive news announcement, or you can short them after a news announcement is concluded. Learning how and when to do so are the essential ins and outs of becoming a profitable “catalyst trader,” which is a type of trading that very few traders are familiar with.
In order to understand the how-tos of “binary event catalyst trading” I interviewed Mark Messier, founder of BioRunUp.com, about how to find the best biotech catalyst opportunities and how to safely trade these stocks ahead of these known catalyst dates. This is a different type of trading than that based on technical or fundamental analysis and it has its own particular rules of dos and don’ts.
Mark, why don't you tell us your background and how you got started in trading?
My background is actually in criminal justice. I got certified as an intelligence analyst for the Department of Justice in California and I was working for a local law enforcement agency doing criminal analysis and intelligence analysis. My family has a blue-collar history of law enforcement, but it wasn't really completely the angle that I wanted to go. I didn't want to be out there on the streets getting shot at. I was doing the criminal analysis type of thing, however, which was always interesting to me.
Can you give us an explanation of criminal analysis and intelligence analysis? Does that background have anything to do with your development of skills in trading the markets?
It is basically studying human patterns and that's kind of where I think the match to trading is. I believe that so much of being successful in trading depends on human psychology, such as understanding the emotions involved in trading and what people are thinking and doing before they do it.
I think this plays closely to criminal justice in terms of tracking crimes because part of what we would do was pattern analysis. It is part of crime analysis to basically try to predict what was going to happen before it happened, and this is very similar with the stock market as far as analysis is concerned. You are basically studying human patterns by using trading patterns and saying, “Okay, this worked in this particular sector or for these particular stocks,” or “There were these particular ingredients that went along with the run-up and it was a very successful trade.” You can even backtest these types of analyses to conclude, “Wow, that made a huge run, it was a very good position,” and so then you can look forward to similar results for the same pre-conditions in the future.
What are the criteria for certain stocks that I want which will show me they are all set to make a good run? The biotech sector is a perfect area for that kind of analysis and that kind of trading because it is all catalyst based. You can see what worked in the past and then just look for those types of positions coming in the future as you are going forward. When you are looking to pick a buy for a certain type of stock you have to set out the right ingredients and make sure they are there before you buy the position.
This criminal analysis analogy sounds really interesting, but it’s still a bit theoretical to me. Can you give me some examples of what criminal analysis is and what you would actually do?
Basically with investigative analysis we would read all the case details of a crime. Say it was a bank robbery and therefore I knew the patterns that the criminal used. Obviously they hadn't been caught yet, but we knew the time of the crime or day of the week that they went into the bank, the clothing they were wearing, the type of bank, where was it located and so on. That's kind of a basic scale. In other words, we basically tried to figure out some patterns of a serial case so that we knew where to move resources to possibly catch the criminal in the future. That's an example of the analysis done for somebody who is robbing banks in a serial fashion and how we would try to best determine where they most likely were going to hit next.
In other words you would say, “Here is an unsolved case so let's try to find any possible patterns within it.” Then you would use your analysis to predict where it is possibly or probably going to happen next and then you would put the resources there?
My mind has always kind of worked in that way. I learned how to pick a direction and that's kind of how my mind works. I didn't know it at the time, but it was a nice transition into the stock market.
When you initially went into the stock market would you say that you were a fundamental investor back then or a technical trader? For instance, were you looking for patterns of fundamental pre-conditions (such as the right P/E ratio) as per your criminal analysis career and then expecting stocks having those criteria to go up? Or were you looking for technical chart patterns that they had to satisfy before you expected a stock to rise?
It's kind of a mix, especially in how I started. What happened was that I had a little bit extra money when I was in college because I had worked for Bank of America for a short period of time. When I was working for Bank of America the stock was at $40 or $50 a share. I hadn’t looked at the market in a long time and it was late 2008 and then the beginning of 2009. I was just listening to the radio while I was driving for work and I heard that Bank of America was down to like $3 a share. I couldn't believe it. I was like, “What the hell is this?”
I was basically ignorant as the market fell apart in 2008 because I wasn't trading the market. When I finally heard the share price of the one ticker that I was familiar with I was like “holy crap.” I knew what a big company Bank of America was because I had worked for them and I thought - it was partly a little naive on my part - but I thought this company is too big to fail, I have a little bit of money and I know where it was trading before. I thought that maybe it was a good idea to take some of that money and start using it in the market and so I did.
That was basically my first foray into trading, which was that I bought Bank of America stock. That trade kind of gave me a taste of the market. Bank of America went up and I then doubled or tripled my money. It wasn't very much money at all. This is going back to my initial $2,480 that I started with in trading during March of 2009 so that was the start of my involvement with the stock market.
While I was researching Bank of America I got into really researching stocks and then I started noticing other tickers around. One of them was Cell Therapeutics, which is CTIC, and that was the first biotech stock that I ever bought. It was under a dollar at the time. I forget the exact pricing but I made a big gain on it. It was like an overnight thing. It started to get some momentum going into a catalyst date. I can't remember if it was a clinical trial or if it was a FDA decision, but there was some sort of catalyst and I watched what took a while for Bank of America to make a move happen much more quickly with CTIC, a biotech stock.
I thought, “Wait a minute here,” and I started looking into different biotech stocks and started finding other ones that had similar catalysts whether it was a Phase 3 trial (that is basically where you get an outcome on a drug in a medical trial) or whether it was a FDA decision. I noticed something incredible with a FDA decision that because it is a government regulatory agency they actually gave a day where they were going to render the decision. I started to find those biotech stocks that were small-cap companies but which had progressed to the point where they were able to submit a drug to the FDA.
These stocks are at the point where the whole company is riding on this decision that the FDA is going to give them. They are not like Pfizer, which every couple of weeks has a drug coming up for a FDA decision and which has blockbusters in the pipeline. We are talking small-cap companies that have built their company around one drug. The FDA decision is a “make it or break it” type of event, but you have a date to trade around for that event.
In my research I started to notice that there is a price run-up pattern around those decisions and that's where the name of my website “BioRunUp” (for BioRunUp.com) came from. I started to notice a pattern with biotech stocks, namely that they would “run up” to these catalyst dates. The beautiful part about it was the following. When we are talking about a regulatory catalyst like a FDA drug approval decision, that date wasn’t something nebulous like “sometime in the first quarter” or “sometime in the second quarter” for when the government was going to announce a decision on whether the drug was approved for public sale. You had a specific date like “March 16, 2015” for example.
You had the exact date?
Exactly. I consider myself to be pretty conservative and so it provided a date to trade around. I noticed something when I looked at the patterns of these dates. I started to pull up previous biotech stocks and they all made a similar move. Around three months before a FDA announcement there wasn’t much volume in the stock and then as it got closer and closer to the catalyst date it just ramped up. This happened every time because everybody started talking about the upcoming decision. It was a big deal for the company and so the share price would go up and it happened every time.
I was like, “Why can't I locate these biotech companies that have catalysts that are definable?” The best ones are the FDA decisions because with those you have an exact date. However, companies at times will give pretty specific guidance even on clinical trials. They will say that they will announce results “maybe in late April” or “we will present at this conference on this date.”
My goal and focus since that time has been locating biotech stocks that have defined catalysts where I can safely enter the trade when nobody is talking about them and then hold into the position while everybody starts to talk about them. Before the attention is focused on the stock every time you will be thinking, “When is this one going to start to move?” Then suddenly out of the blue everybody is talking about it and it runs up to that catalyst. Then you have a choice. You have a decision to make.
Personally, I don't like to hold through catalysts. I have seen them become positive and then there is a sell reaction on the news announcement (a “sell on the news” reaction). This is extremely common in biotech because there are a lot of retail traders that come in and when they don't see the stock immediately move in the direction they want on a positive catalyst then everybody sells at once and the share price drops.
There are just so many variables after the fact of an announcement, which can hurt the stock price whereas you can consistently be making gains up until that point. That is why I like to exit positions before a catalyst announcement date. There is no need to take the risk of holding the stock through the actual catalyst itself when you already have substantial gains and there are plenty of other biotechs to roll to the next catalyst.
It seems you are like a lot of professional traders who have weaned themselves off emotions to become successful. It sounds like you are just trying to make money with the trade and then go onto the next one rather than trying to hit one big home run. You just want to make some money with minimal risks and then move onto the next trade.
Absolutely. I found over time that there are so many catalysts and trades that you can be in without taking that risk of holding on through the actual event. This is one of the rules for this type of trading: you cannot fall in love with a biotech stock. I have seen people do that so many times. They fall in love with the story, they fall in love with the drug, they start dreaming of huge gains and sales and the stock going up ten times overnight. They fall in love with the stock and become blinded at anything that could be a negative sign about the company and they end up getting hurt.
Let me summarize everything so far. You got involved in trading because you were working at Bank of America and bought some stock after its price collapsed figuring that it would have to rebound. Afterwards you looked around at other low priced stocks and noticed that one of them, which was a biotech stock, started moving like crazy even faster than when Bank of America’s stock rebounded. That's what steered you towards focusing on the biotech sector.
Exactly, and I noticed a trend. If this small-cap stock can move this quickly then I figured there has got to be more like them. What are the key ingredients, what is the trend that is the same with these fast movers? Number one was that they were biotech stocks and number two was that there were definable catalysts.
I don’t do this for large-caps drug companies. For instance, you will have Pfizer get a FDA approval and the stock will only go up half a percent. There is no move. What really breaks it down is companies where they are really financially riding on this decision to come home. At BioRunUp.com we keep a database of mostly small company biotechs and there are over three hundred companies in there with potential catalysts coming up.
Does that mean there are three hundred potential trades in a year, or would it be six hundred potential trades a year because of two dates? Can you explain what those dates are and the difference between a FDA decision and clinical trial announcement? How many trades are potentially possible a year?
I would say that in the small-cap space there is probably up to a thousand trades potentially because companies have multiple catalysts. I will try to break it down, but I don't want to get too technical and overload people with information because it sounds much more difficult than it is. But basically, between getting a drug from testing to approval it goes through Phase 1, Phase 2, Phase 3 and then the company can submit the drug to the FDA for a decision on whether or not it can sell the drug.
Each clinical trial gets larger and larger and larger. In Phase 1 they might merely have ten people they test the drug on, and then in Phase 2 they may involve one hundred and fifty people, and in Phase 3 they may have one thousand five hundred people because they just move it along within the process. The higher the phase clinical trial usually the more the stock will react because it is just one step closer to getting to the point where they can submit it to the FDA for review of all the data. The FDA will assign them a date where they will issue them a decision and then once they get that positive decision they can market it and sell it and that's when everything happens.
One company from beginning to end can have multiple catalysts through the entire process for one drug. You have Phase 1, Phase 2 and Phase 3 and then the FDA's submission. For some companies like CTIC - I am still trading CTIC which was the first biotech I ever traded and I think this is the same drug as five years ago - it takes years to go through the whole process.
In other words, a Phase 1 catalyst would be a company’s Phase 1 announced clinical trial results, a Phase 2 catalyst is the company’s Phase 2 announced clinical trial, and a Phase 3 catalyst is the same thing whereas the “FDA decision” is the final decision where the FDA gives the biotech company a binary “yes” or “no” ruling on whether they can market the drug or not.
Yes. One word we use all the time is PDUFA, which stands for “Prescription Drug User Fee Act.” It is the law that Congress passed allowing drug manufacturers to collect fees to help fund the drug approval process, but that is basically what the FDA calls the process of issuing approval for a drug. The FDA catalyst is the PDUFA date. The FDA decision, or FDA catalyst, is the PDUFA.
You mentioned that there is usually a substantial price run-up in a biotech stock before a company’s catalyst, which is what you trade on the bullish side. What is the best lead time ahead of the catalyst dates that is optimal for getting into a trade? Other than just the upcoming date alone is there also an accompanying volume pattern or chart pattern that is also necessary for a potential trade? In other words, what is the normal lead time before a catalyst and how do you actually decide whether to get into a particular trade when there are so many options available?
Usually it depends on the market. One part doesn't depend on the market, which is that with standard reviews we will know about ten months ahead of time when the FDA decision date is. That's part of the process. They submit to the FDA and then the FDA says, “Okay, we have accepted your submission and we will issue you an approval decision on this date in the future.” For a standard review that is about ten months out. For a priority review where the FDA says this is a drug with an unmet need then that is six months out.
We have those dates that far in advance. Usually the biotech stock does not start to move until right before a catalyst. We are in a bull market right now and biotechs are really hot right now so anything with a catalyst date is going to really start to run. If it's a market like this then three to four months out you can buy the stock and just tuck it away.
Obviously there are other factors that I look at such as whether the company needs to raise cash, how much they are burning, etcetera because I may not want to buy a stock four months out if they are running out of cash and I know they are going to offer before the catalyst. Then I may hold off, but generally speaking in a bull market like we are in then three to four months out you can buy the thing and tuck it away.
You have three hundred of these potential dates. How do you tell which ones to trade? What are your specific criteria?
In order to get down to an actual FDA decision we have a database with over three hundred catalyst events in it. Within a year there are probably fifteen to twenty that actually come up for a PDUFA, meaning a FDA decision. Those hundreds of events then whittle themselves down to the ones that we are going to watch. Those fifteen to twenty are the best ones to trade. Those are the tightest catalysts and get the most attention because they are FDA decisions.
You mentioned that a Phase 1 trial might involve ten people while Phase 2 and Phase 3 trials involved more people, and that the stock price at those times usually shows larger volatility. I know there is no real number you can tag to what happens at each clinical trial phase announcement, such as “favorable Phase 1 trials can jump a stock 10%, Phase 2 trial results can typically cause 30% price increases, Phase 3 positive results usually lead to 50% gains” and so on, but are there any tendencies you have noticed along these lines? In particular, I’m very interested in finding out what usually happens pricewise with positive FDA announcements.
It's hard to give a number for these things because it is so dependent on the specifics such as what the drug is trying to treat and how good the data is. Phase 1’s may not get a lot of price bump because the results are based on such a small sample size. Phase 2’s generally tend to get more volatility and you get a better idea of the drug’s future from a Phase 2 trial. If a drug is going to fail it usually does so in Phase 2 because in Phase 1 you can't get a statistical analysis. Basically you are making sure that it's safe and they think it's kind of working in Phase 1. In Phase 2 you get to the point where there are enough people involved in a trial where things can become statistically significant. Phase 3 is almost like, “We just want a larger sample size.”
Phase 2 can be the most volatile although when you get Phase 3 data that is what they are going to be presenting to the FDA for approval. It is the most important date, but as far as the turning point is concerned then when it comes to what means the most and what can come out of the blue and surprise then a lot of times it is Phase 2.
What percentages are the stocks usually moving because of these catalysts?
It's so hard to give that kind of answer because we've seen ones that make 200% moves because the market was not expecting it and it surprised people. There is a lot of guesswork that goes into estimating a drug’s potential and the potential price movement for a positive announcement.
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