Following the announcement of positive mid-phase testing for its schizophrenia treatment KarTX, Karuna Therapeutics, Inc. (NASDAQ:KRTX) enjoyed a 443% gain on November 18 and a 29.2% gain on November 19 to close at $123.99. That Tuesday's close represented a 6X+ gain over the previous Friday's close (below $18).

We've had some time to let the buzz simmer down. As of November 22nd's close, Karuna stood at $85.01 – a 31.44% loss from its weekly closing high, but still a 370%+ overall gain from before the mania. The pullback was at least partially attributable to the company's offering of 2,600,000 shares of its common stock to the public at $96 per share after the surge.

Risk and reward

Image Source: Getty Images

The Midphase Munchies

Biotech is the fast lane for buy-and-hold enthusiasts. The mid-phase munchies (Buffett might just call it "greed") will make otherwise rational individuals start spazzing on the execute button like OTC day-traders if news comes out about a successful mid-phase trial. They usually buy high and get stuck when short-term trade specialists unapologetically cash out. Mid-phase munchers wait desperately for another turn to the positive, but usually end up holding the bag waiting on phase 3 while the stock loses its legs and skews bearish.

To the contrary: Even if you bought at the very top of the mania, -31.44% profitability is not the end of the world in biotech. Stocks routinely double on a successful phase testing. A new drug on the market means long-term viability. This article on Karuna gives you all the medical details; suffice it to say that a successful KarTX has a legitimate corner on the market for schizophrenia treatments.

Karuna also benefits from its recent stock offering, which is expected to nearly triple the company's cash reserves from $161 million to approximately $449 million. That's quite a lot more money to make sure KarTX completes its trials, complies with regulations and successfully makes it to market. 

Moving Forward – Sell or Hold?

The real problem is your risk profile. If looking at swings of ±50% make your stomach turn, stay away (or get out now if you bought). The lesson is worth more than the loss. The uncertainty of phase 3 success coupled with a drop in volume will likely slow Karuna down in the coming months. Expect a slow burnout until phase 3 buzz hits the street. 

...which may mean great buying opportunities if you're bullish. 

The stock may benefit from a general resurgence of funds back into biotech after $11 billion in net outflows over the first three quarters of 2019 (compared to $430 million net outflows Q1-Q3 2018). Top biotech ETFs like iShares Nasdaq Biotechnology ETF (NASDAQ:IBB), and SPDR S&P Biotech ETF  have each gained around 9% over the past month from their lows in late September. An FDA approval from Amarin (NASDAQ:AMRN), phase 2 success from Arrowhead (NASDAQ:ARWR) drug JNJ-3989 and other big wins in the sector helped bring retail investors back into the fold. All of this means more eyes on high-flying Karuna, which admittedly needs volume over time to help early buyers justify their holding patterns.

At the very least, KarTX's performance, outpacing both AstraZeneca's (NASDAQ:AZN) Seroquel and Pfizer's (NYSE:PFE) Geodon – with millions less in R&D – is definitely something to watch. If you were lucky or skilled enough to get in early, you might sell enough stock to play with house money and conduct your research knowing you're in the black regardless.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.