Biogen’s Big Gap Down on Thursday a Lesson For Traders

Biogen

Investors think nothing of holding a stock overnight, and makes sense for their strategy. The situation is much different for traders who use leverage, where this becomes unwise.

The road to getting a drug or other treatment to market is a long one, and this long lead time gives us a good picture of how a company who makes and markets these treatments may fare down the road. Stocks are really about down the road more than they are about what is going on now, so news that relate to a company’s pipeline can matter a lot more than how the business is doing.

Biogen, a leading biotech company, has actually been doing pretty well lately, and 2018 was a particularly good year for them. While 2017 saw their profits drop from $3.7 billion to $2.54 billion, 2018 came in at $4.43 billion, an all-time record for the company and a 75% increase year over year. Their fourth quarter results were also the strongest quarter they have ever experienced, so there is momentum here as well.

None of this had anything to do with their stock plummeting during after-hours trading, seeing it drop from $320.47 when the Nasdaq closed Wednesday, all the way down to $232.83 when the market opened again.

While it may appear like stocks go to the dark side of the moon when its main market closes, the price set at the open isn’t just some arbitrary number or the price that the first traders of the day settle on. It is instead based on how the trading proceeds during the time that the market is closed, on other markets.

Companies prefer to announce big news like earnings reports or disappointments during off-market hours, to let this smaller volume trading get the battle underway early, as well as to shield the regular market from price shocks that could trigger more panic and especially risk an overreaction by computerized trading programs.

It’s not that people don’t panic or over-react during the off-hours, but the weight of the trading that goes on during this time allows for news to be cushioned more than they perhaps would be if these things were announced in-session. We already see such things happen during trading hours with events, which are often over-reacted to, and traders will often wait until the selling is over and jump on to capture the over-selling part of the move as it corrects.

There is less of an opportunity to do this with big gaps down, because the issue may not be fully vetted and priced in during the early hours of regular trading. This is the case with Biogen, as the market decided that this discount wasn’t quite big enough and took a little more for good measure.

We did move up a bit during the first few minutes, but the initial hope that this was an overreaction had little behind it, and the bears quickly brought things below the open in short order.

Changes in Stock Prices Are All About Changing Perceptions

The reason for all this fleeing from the stock and seeing its value so much lower than the day before has nothing to do with the company’s current fortunes, and we say that everything we know at the current moment is priced into the stock already. When the situation with a company changes, this will alter how we value the stock, and produce price changes in that direction.

We learned that Biogen has halted its trials of a potential treatment for Alzheimers, and the stock was seen as worth a whole lot less, in the blink of an eye.

Perceived value plays a big role in this, and in fact can be said to be what stock prices measure. Every trade as a buyer and a seller, and it’s when their expectations change that they start asking for less and willing to pay less.

Biogen is a perfect example of this phenomenon, because of how the price shock makes how stocks move more transparent. The news hit, and market makers saw it, and made huge adjustments in price to account for it. This is not unlike when we see an issue halted and then re-open much lower, and the same thing happens then, with the difference being that traders are given a chance to catch their breath before being hit with the bad news.

No trading goes on while a stock is halted of course, so it wasn’t the selling that drove the price down, since there wasn’t even any selling at all. What we see instead is a re-evaluation at the market maker level, and then resume trading after this new level is set.

These moves can’t be traded, and even the nimblest traders cannot outflank the market makers that set these new prices, because the market makers get to go first. Some of these events are announced, but not all are. Having these things announced after market hours does a great favor to traders who need to control risk enough to be well advised to steer clear of this additional risk.

There’s no good way to protect yourself from halts, because stop orders rely on actual trades, those at or below the stop, and if the first one is way below where you needed to get out, this is where you are now at.

It Doesn’t Make Sense to Leverage the Unknown and Unmanageable

However, when this sort of thing happens after you have closed your positions for the day, you avoid these after-hours blights. If you are using leverage, this will magnify both the shock and its effect upon your account.

This is a huge reason why so many traders never hold positions overnight, and the gap down with Biogen really demonstrates why not. If you are leveraged 4:1, as traders tend to be, you woke up on Thursday to discover that your position has been closed, you have lost all of your money, and you even owe your broker on top of all this.

Investors, on the other hand, will, just have to take their lumps when these things happen, as they never look to avoid overnight risk, or even exit a position in anticipation of a major news announcement. This is just part of the overall risk that stock investing involves.

If we are using leverage with trading stocks, we do need to be aware of the additional risk that overnight trading involves. While a lot of traders hold leveraged positions overnight, the good ones are more aware of the fact that this is not a time where using leverage is warranted, when you are fully relinquishing your control over the position and subjecting it completely to the whims of the market. There is no advantage here we can seek to multiply, and that’s the only reason why we leverage, to multiply proven advantages.

This can be a perfectly fine strategy with non-leveraged positions, especially if you aren’t managing your positions day to day anyway, so whether something goes on overnight or during market hours isn’t really an issue.

Leveraging is a very powerful tool for traders but it’s power cuts both ways. Proper risk management with trading is not optional, and it is especially required when we leverage. We need to make sure we use it with care and especially not subject our portfolio to the potential to turn painful but manageable losses into ones that can cause significant damage to our accounts.

Biogen is an example of what can happen to a stock overnight, as was Boeing recently. These things do happen, and we need to be aware and prepared.