Although the S&P 500 has made a substantial recovery off its late-August lows, the technical condition of the broader market is still shaky.
For starters, the death cross (200-day moving average crosses below the 50-day) is still in force on the index. The same technical configuration applies to both the Dow Jones industrials and transports as well.
Further, overhead resistance on the S&P 500 looms close by. The declining 50-day moving average is at 2,039. Slightly above is strong lateral resistance near 2,045, which was the previous support level. For the cherry on top, many technicians believe a double-bottom will need to be traced out before any all-clear signal can be given.
In this environment, weak stocks make good shorts, and one of the most vulnerable is XenoPort (Nasdaq: XNPT). The California-based biopharmaceutical firm focuses on developing treatments for neurological and autoimmune disorders.
The stock suffered an enormous blow on Sept. 15, when shares plummeted 28% on staggering volume following news the company's psoriasis drug, XP23829 -- currently in a mid-stage, Phase II trial -- caused negative and potentially harmful side effects, including diarrhea, stomach pain and vomiting. Due to these health risks, nearly a third of the 200 patients involved in trials pulled out.
Despite this setback, the company plans to proceed with a Phase III clinical trial in 2016. But it remains to be seen whether XenoPort can iron out the difficulties to make its drug commercially viable.
With the success of XP23829 in question, XenoPort is in a fragile position. The company currently only sells one other drug, Horizant (Regnite in Japan), used to treat restless legs syndrome. Horizant accounted for 95% of the company's revenue in the recently reported second quarter.
While total revenue was up 62% year over year in Q2 to $8.6 million, expenses of $25.6 million outstripped sales by a long shot. Losses widened to $24.5 million in the second quarter from a loss of $19.4 million a year ago.
For the upcoming third quarter, to be reported in early November, analysts expect revenue to plummet 62.1% year over year to $11.8 million. They predict a net loss of $0.38 per share compared with a $0.13 per-share profit in the year-ago period.
The picture is equally grim for the full 2015 year. Analysts estimate revenue will drop 10.1% to $42.1 million. Earnings are projected to slip to a loss of $1.45 per share compared to a loss of $0.81 last year.
In addition to the weak revenue and profit outlook, the company has an extraordinarily high total debt-to-equity ratio of 214.7.
Traders certainly appear to have lost confidence in the stock, as shares continue to fall to fresh 52-week lows.
As the chart shows, XNPT hit an important low just above $3 in May 2014. From there, shares almost tripled by late November, and then hit a high of $9.60 in January.
Following that high, the stock declined and tested the major uptrend line in May and August.
The break of the trendline occurred last week as XNPT plummeted from about $7 to a low of $4.18 on much higher-than-average trading volume. A large bearish engulfing candle now sticks out like a sore thumb on the right side of the chart.
As shares fell, they knifed through historical support near $5 dating back to October. This level should now mark extremely strong resistance on any rally attempt.
There is some tentative support just above $4; however, it's more likely shares will retest the all-time low a little north of $3. This was the level the stock touched in May 2014 before it reversed course. But if the company cannot iron out problems with its psoriasis drug, shares could go even lower.
Given XenoPort's bleak technical and financial outlook, exacerbated by the clinical trial news, this biopharmaceutical company seems like a prime short candidate.
Recommended Trade Setup:
-- Sell XNPT short at the market price -- Set stop-loss at $5.13 -- Set price target of $3.15 for a potential 25% gain by year end
Note: A 25% gain in less than four months is certainly nothing to scoff at, but certain traders have made even bigger profits on falling stocks in a shorter amount of time:
-- A 33.9% profit on Keurig Green Mountain (Nasdaq: GMCR) in 56 days
-- A 40.4% profit on Yelp (NYSE: YELP) in 29 days
-- A 30.4% profit on Wynn Resorts (Nasdaq: WYNN) in nine days
-- A 40.5% profit on Dillard's (NYSE: DDS) in seven days
-- A 69% profit on Alibaba Group Holding (NYSE: BABA) in nine days
And each of these gains came on a significantly smaller down move in the underlying stock. Find out who is making trades like this and get the chance to try the next few trades risk free by clicking here.
This article was originally published on ProfitableTrading.com: This Biotech is Headed for a Steep Drop