Chelsea Therapeutics and Accuray: A Lesson on Stop-Losses

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What I write here is not intended as a trading service. I do often highlight a particular stock or ETF that could be bought or sold if you agree with my overall analysis, but rarely do I just recommend something outright. In December, however, I did, with this article that recommended two small stocks in the healthcare sector that I considered worth buying, Chelsea Therapeutics (CHTP) and Accuray Inc. (ARAY).

At the time Chelsea Therapeutics (CHTP) was awaiting the FDA decision on its drug designed to treat orthostatic hypotension (dizziness on standing) in those suffering from Parkinson’s and other autonomic diseases. That approval was granted yesterday in a decision delayed by the extreme weather, and the stock reacted accordingly. I wrote that piece on December 9th and CHTP closed that day at $3.73. As I write, the last pre-market trade in the stock was at $7.16 (+ 91.95%).

It has certainly not been a smooth ride to this point, and the chart since early December can teach us several lessons about this type of investment.

CHTP

In the original article, I stated that this was a time when a stop-loss order would be out of place. The goal was to hold the stock until approval for Northera, the drug concerned, was granted or denied. As you can see, holding on took some courage, but if you did, you have been rewarded.

The approval for new drugs such as this comes in two stages. First, a month before the full decision is given (in this case on January 14th) the advisory panel gave their recommendation. The panel advised approval of the drug, but not before rumors had surfaced that they would not. These rumors caused CHTP to plummet to a low of $2.26 on January 10th, and this price action points out the dangers of this type of trade.

All stocks can be influenced by rumors, but in the case of a thinly traded company such as CHTP, the swings can be particularly violent. I am not a big conspiracy guy, but when you see a pattern like this it is hard to escape the conclusion that somebody was trying to force the stock down before that recommendation was released.

I am not saying that this is actually what happened here as I have no evidence that would support that, but the point is simply that if you make a risky trade such as this with a specific goal in mind, you should ignore the rumors and wait for that specific goal. It is easy to convince yourself that somebody has some inside information, but in reality that is rarely the case. Once you set logical parameters for a trade, stick to them.

Accuray, by comparison, has been a fairly straightforward hold.

This was an execution, rather than approval, story, so in the original article I did suggest an accompanying stop-loss, in this case at around $6 representing a potential loss of around 25%. ARAY never got down to those levels and the company has continued to expand sales of their laser surgery technology and is currently trading at around $10, a roughly 25% increase.

The point here is not to cherry pick a couple of stock picks that worked out, but rather to highlight the fact that stop-loss orders, while a useful tool in many circumstances, should not be used every time. I spent twenty years being paid to understand traders, and learned in that time that there were certain things that the successful ones had in common.

Most importantly, those that succeeded had a clear plan going in to any trade and stuck to it. Every situation is different and each calls for a different strategy. Once money is at stake logical decisions are harder to make, so having a plan hatched without the emotional pressure of profit and loss is a good habit to form.

At the time of writing, the author is long both CHTP and ARAY



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Basics , Stocks

Referenced Stocks: CHTP , ARAY

Martin Tillier


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