BALTIMORE (Stockpickr) -- While most retail investors are focusing on which stocks to buy this earnings season, there's an edge in thinking about something that most investors don't think about nearly enough: which stocks to sell.
Fact is, even though the broad market is looking at a 1.5% pop in the S&P 500 so far this week, not all names are participating in the rally. As I write, one in four S&P components are actually down since Monday. The worst performers are down considerably this week. Put simply, a big chunk of the market isn't participating in the upside -- and those are the names you don't want to own now.
A very specific chunk of the market looks "toxic" right now. Today, we'll take a look at which stocks you should avoid.
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 entry and exit points.
So without further ado, let's take a look at five "toxic stocks" you should be unloading.
Up first is mid-cap precious metals stock Tahoe Resources (TAHO) . The last year has already been a rough time to own Tahoe. In the trailing 12 months, this miner has shed 43% of its market value. The bad news is that TAHO could have further to fall soon, thanks to a bearish technical setup that's been forming in shares all year long.
Tahoe Resources has been forming a descending triangle pattern since the end of 2014. The descending triangle is a bearish continuation pattern that's formed by horizontal support down at $11, and downtrending resistance to the upside. Basically, as TAHO has been bouncing in between those two technically significant price levels, it's been getting squeezed closer and closer to a breakdown below its price floor at $11. When that happens, we've got our sell signal.
Relative strength, at the bottom of the chart, is an extra red flag in TAHO. That's because our relative strength line has been in a downtrend since last summer, an indication that this stock isn't just losing steam here, it's also significantly underperforming the rest of the market. As long as our relative strength downtrend stays intact, Tahoe Resources will keep underperforming the broad market. This stock chart may already look ugly here, but it becomes toxic with a move below $11.
We're seeing the exact same price setup in shares of $14 billion auto and industrial parts stock Genuine Parts (GPC) - Get Genuine Parts Company Report. Like TAHO, GPC is currently forming a descending triangle pattern, in this case with support at $92. The big sell signal comes if that $92 line in the sand gets violated.
Why all of the significance at $92? 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 GPC's shares.
That $92 level in GPC is a 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 $92 price in GPC. Once sellers knock out that level, you don't want to own it.
American Assets Trust
Things haven't been so bad lately in shares of American Assets Trust (AAT) - Get American Assets Trust, Inc. Report. In fact, this $2 billion retail REIT has seen its shares climb more than 23% since the beginning of October -- on top of a 2.2% dividend yield. But if you own AAT, now might be the time to think about taking some gains off the table. The rally in this stock is starting to show some cracks…
AAT is currently 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 AAT that's the $40 support level on the chart.
If $40 gets violated, the next-nearest support level in AAT is down at $33. The good news is that the $40 breakdown isn't set in stone here – technical analysis is a risk-management tool, not a crystal ball. For that reason, it's critical to be reactionary and wait for support to get broken before you sell. On the other hand, if prior highs at $45 get taken out, then this stock's downside pattern is invalidated.
Summit Midstream Partners
Like a lot of other stocks in the energy sector, Summit Midstream Partners (SMLP) - Get Summit Midstream Partners LP Report has been looking toxic since last summer. In that stretch, this $2 billion commodity infrastructure stock has seen shares drop about 35%. The bad news is that, even down at these levels, SMLP still looks like a bad buy.
And you don't need to be an expert technical trader to figure out why.
SMLP has been bouncing its way lower in a downtrending channel, swatted down on every test of the top of the channel. The price channel in SMLP is formed by a pair of parallel trend lines that identify the high probability range for this stock to stay within. So, as shares bounce off the top of the channel this week, it makes sense to sell.
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 SMLP.
Digital Realty Trust
Last up on our list of "toxic" names is another REIT, Digital Realty Trust (DLR) - Get Digital Realty Trust, Inc. Report. After spending most of the last year and change in rally mode, DLR is starting to show some cracks, in no small part thanks to a hefty dividend yield and the constant rate hike reminders being advertised by the Fed. But while rate hikes look like they're months away at the soonest, a breakdown in DLR looks like it could come sooner than that.
DLR 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 Digital Realty's neckline just below $63. In other words, if $62.50 gets violated, then look out below.
Lest you think that the head and shoulders is 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 a good reason to keep a close eye on DLR's $62.50 level here.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.