BALTIMORE (Stockpickr) -- And just like that, stocks are back to breakeven. With March's decline in the S&P 500, the big market indices are once again flat for the year, which means that we're ending the first quarter of 2015 no better off than we started it.
Of course, the big market averages only tell part of the story here. More than half of the S&P's component stocks are down year-to-date right now, which means that it hasn't been hard to materially underperform in 2015. I'm not making a big bearish call here; there are still some big opportunities to buy stocks. But frankly, that's not what most people should be focusing on.
Not owning the wrong stocks has meant a lot more for your portfolio in 2015 than owning the right stocks has. That's why we're taking a technical look at five names that look toxic here. In other words, these are the stocks that you don't want to own.
Just to be clear, the companies I'm talking about today aren't exactly junk. By that, I mean they're not next up in line at bankruptcy court. But that's frankly irrelevant; from a technical analysis standpoint, sellers are shoving around these toxic stocks right now. For that reason, fundamental investors need to decide how long they're willing to take the pain if they want to hold on to these firms in the weeks and months ahead. And for investors looking to buy one of these positions, it makes sense to wait for more favorable technical conditions (and a lower share price) before piling in.
For the unfamiliar, technical analysis is a way for investors to quantify qualitative factors, such as investor psychology, based on a stock's price action and trends. Once the domain of cloistered trading teams on Wall Street, technicals can help top traders make consistently profitable trades and can aid fundamental investors in better entry and exit points.
So without further ado, let's take a look at five "toxic stocks" you should be unloading.
Up first is Suncor Energy (SU) - Get Report. You probably don't have to be too prescient of a market-watcher to figure out what Suncor's chart has looked like lately. With the whole energy sector in selloff mode for the last six months, pretty much any issue with the word "energy" in the name has been moving down and to the right. Suncor is no exception, but it could be set to another big move lower in the near-term.
Suncor is currently forming a descending triangle pattern, a bearish price setup that's formed by horizontal support down at $27 and downtrending resistance to the upside. Basically, as SU bounces in between those two technically important price levels, it's been getting squeezed closer and closer to a breakdown through that $27 price floor. When that happens, we've got a new sell signal in SU.
Relative strength, at the bottom of the chart, is an extra red flag in SU. That's because our relative strength line has been in a downtrend of its own since last summer, an indication that shares aren't just losing steam here, they're also significantly underperforming the rest of the market. As long as our relative strength downtrend stays intact, SU will keep underperforming. But a violation of $27 is the big signal that more downside risk just opened up.
We're seeing the exact same price setup in shares of $5 billion filtration equipment manufacturer Donaldson (DCI) - Get Report. Like Suncor, Donaldson has spent the last several months forming a descending triangle pattern. While DCI's chart is a little more cluttered than the one in SU, the trading implications are exactly the same. DCI becomes a sell on any violation of $36 support.
Why all of the significance at $36? It's not magic. Whenever you're looking at any technical price pattern, it's critical to keep buyers and sellers in mind. Patterns like the descending triangle are a good way to quickly describe what's going on in a stock, but they're not the reason it's tradable. Instead, it all comes down to supply and demand for Donaldson's shares.
That $36 level in DCI is the spot where there's previously been an excess of demand for shares; in other words, it's a price where buyers have been more eager to step in and buy shares at a lower price than sellers were to sell. That's what makes a breakdown below support so significant -- it means that sellers are finally strong enough to absorb all of the excess demand at the at price level. Keep a close eye on that $36 price in DCI. Once sellers are in control again, you don't want to own it.
Semiconductor stock Applied Materials (AMAT) - Get Report has actually had a pretty decent run in the last year. Over the past 12 months, this $27 billion tech stock has climbed 13.5% higher, edging out the S&P's return over the same period. But the rally has been showing some cracks lately. With a key break of support this week, AMAT owners might want to think about taking gains.
Applied has spent the last several months forming a double top pattern, a bearish reversal setup that looks just like it sounds. The double top is formed by a pair of swing highs that peak at approximately the same level. The sell signal comes on a violation of the trough that separates those two tops. For AMAT, that was the $22.75 level that got busted yesterday. Shares aren't far from that level yet at this point, but that could soon change.
Momentum is the side-indicator to watch in AMAT. While Applied achieved its prior price ceiling back in February, our momentum gauge, 14-day RSI, made a lower high. That's an indication that buying pressure was fading into the end of the double-top pattern. Short-term, AMAT's most likely direction is further down.
It takes some skill to correctly pronounce Companhia de Saneamento Basico do Estado de Sao Paulo (SBS) - Get Report, the full name of the Brazilian water utility better known to U.S. investors as Sabesp. The good news is that you don't need quite as much skill to figure out what's going on with this chart. The bad news is that it doesn't look pretty.
SBS has been bouncing its way lower in a downtrending channel since July, swatted lower on every test of the top of the channel. The downtrend in SBS is pretty well defined by a pair of parallel trend lines that identify the high-probability range for shares to stay stuck within. And now, as shares come off of resistance for the fifth time, it makes sense to sell the bounce.
Waiting for that bounce lower before clicking "sell" is a critical part of risk management for two big reasons: it's the spot where prices are the highest within the channel, and alternatively it's the spot where you'll get the first indication that the downtrend is ending. Remember, all trend lines do eventually break, but by actually waiting for the bounce to happen first, you're confirming that sellers are still in control before you unload shares of SBS.
Last up on our list of toxic-looking stocks is Knowles (KN) - Get Report. Remember, price action has everything to do with how investors feel about a stock, and glancing at KN's chart tells you a lot about how its shareholders must feel right now. In the last 12 months, this stock has lost more than 38% of its market value -- and it's not showing any signs of life.
In fact, KN actually looks ready for another leg lower here. Since October, this stock has been forming a head and shoulders top, a setup that indicates exhaustion among buyers. The setup is formed by two swing highs that top out at approximately the same level (the shoulders), separated by a higher high (the head). The sell signal comes on a move through Knowles' neckline at $18. If $18 gets violated in KN, then look out below.
Typically, the head and shoulders is a reversal pattern that comes at the end of an uptrend. That's not the case in Knowles. This stock's head and shoulders setup is showing up at the bottom of a downtrend. Ultimately, that doesn't change the trading implications for this stock; the bottom line is that if shares violate $18, then you don't want to own it anymore.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.