BALTIMORE (Stockpickr) -- "It's a market of stocks, not a stock market." Yes, that's a trite, overused saying, but never has it been more meaningful than this week. While the S&P 500 has been pressing up against new highs in recent days, market internals have been weakening. In other words, the big index is making higher ground on the strength of fewer and fewer stocks.
If you're continuing to use what's been working in this market for the last 15 months, then buckle in -- it's not working anymore. The biggest momentum names of late are rolling over, and money is flowing into the laggards of last year. Put simply, a lot of big name stocks are starting to look toxic to your portfolio right now.
And you might even own some of them.
So which stocks are set to drag your portfolio the lowest in the next few months? Today, we're taking a technical look today at five toxic stocks you should start selling.
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 onto 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 planning their stock execution.
So, without further ado, let's take a look at five toxic stocks you should be unloading.
First up on the list is AES (AES) - Get Report, the $10 billion Arlington, Va.-based electric utility. AES has been a strong performer in recent months as yield-chasers dumped cash back into utility stocks. But if you missed the move in AES, it's best to leave it alone -- and if you own it, we're coming up on an optimal time to be a seller.
AES is currently forming a descending triangle pattern, a bearish technical setup that's formed by a horizontal support level below shares at $13.50 and downtrending resistance above shares. Basically, as AES bounces in between those two technically significant price levels, it's getting squeezed closer and closer to a breakdown below that $13.50 price floor. When that happens, AES officially becomes a high-probability sell.
Momentum, measured by 14-day RSI, adds some extra confidence to downside in AES this week. Our momentum gauge has been trending lower over the course of the price setup, an indication that down days are getting the better of up days in this stock. Remember, momentum is a leading indicator of price.
We're seeing a similar setup in a smaller name: French seismic equipment maker CGG (CGG) . Like AES, CGG is stuck in a descending triangle setup. The big difference here is that the CGG outlook is more textbook -- this stock has already been stuck in a steep downtrend, falling more than 29% in the last six months. The pattern in CGG points to more downside on a violation of $14.50.
The significance of that $14.50 level isn't magic. Whenever you're looking at any technical price pattern, it's critical to keep buyers and sellers in mind. Descending triangles 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 shares.
That horizontal $14.50 support level in CGG 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 -- the move means that sellers are finally strong enough to absorb all of the excess demand at the at price level. So if $14.50 gets taken out, you'll want to join them in unloading shares.
Things are a little more straightforward in shares of Chesapeake Energy (CHK) - Get Report. Chesapeake has been bouncing its way lower in a downtrending channel for the last six months, grinding investors with losses all the way down. No, CHK isn't in free-fall; shares are only 6% lower since they peaked in October. But they're down 6% over a period when the S&P 500 actually rallied another 6%.
So with no upside in sight from here, CHK looks toxic right now.
Chesapeake's downtrend is about as simple as it gets. The channel is formed by a pair of parallel trend lines: a resistance line above shares and a support line below them. Those two lines on the chart provide traders with the high-probability range for CHK's shares to stay within. This week, as CHK presses up against to the top of the channel for a sixth time, it makes sense to sell (or even short) its next move lower.
Waiting for that move 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 ensuring that sellers are still in control before you unload your stake in CHK.
After rallying more than 27% since October, shares of $60 billion chemical giant Dow Chemical (DOW) - Get Report are starting to show some cracks. Dow's status as a "quality" name in 2014 can't spare it from toxic status this year. Here's how to trade it.
DOW is forming a textbook head and shoulders pattern, a bearish reversal setup that indicates exhaustion among buyers. The head and shoulders 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 Dow's neckline level at $48.
Not surprisingly, relative strength has been excellent in DOW since December, while the big chemical stock stomped the broad market's performance. But the uptrend in relative strength broke at the end of last month, sparking a big add-on indicator for the price setup in this stock.
While the relatively short size of the pattern comes with shorter-term trading implications when it triggers, it doesn't change the toxicity in shares right now. If $48 gets violated, it's time to join the sellers.
Last up on our toxic list is Cemex (CX) - Get Report, another name that's showing a head and shoulders top right now. Even though there isn't a lot of overlap between the businesses of Dow and Cemex, the correlations between both stocks is through the roof -- that's why investors should be getting ready to protect themselves by unloading shares.
The key level to watch in Cemex is $12. That's the neckline level that needs to get broken to turn CX into a high probability downside trade.
Yes, the head and shoulders is a well-known price pattern. But if you think that setups in DOW and CX are too well known to be worth trading, the research suggests otherwise: a recent academic study conducted by the Federal Reserve Board of New York found that the results of 10,000 computer-simulated head-and-shoulders trades resulted in "profits [that] would have been both statistically and economically significant."
That's good reason to keep a close eye on both names this week.
To see this week's trades in action, check out the Toxic Stocks portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
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At the time of publication, author had no positions in stocks mentioned. Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation. Follow Jonas on Twitter @JonasElmerraji