BALTIMORE (Stockpickr) -- As an investor, there's nothing more frustrating than losing money during a period when the broad market is up -- even when it's not up much.
So while the S&P 500's 2% year-to-date "rally" isn't much to write home about, making money in this environment isn't as important as not losing money. That's highlighted by the fact that the stocks that aren't working in 2015 really aren't working. Of the nearly 40% of the S&P 500 that's down this year, nearly a third of those stocks are down double-digits. It doesn't take owning many of those stocks to absolutely torpedo your portfolio this year.
In other words, a very specific chunk of the market looks "toxic" right now. Today, we'll take a look at which ones 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 on our list of toxic stocks is poultry company Sanderson Farms (SAFM) - Get Report. It's not hard to see that SAFM has been a big drag on investors' performance lately. Since last summer, this small-cap chicken company has shed 21% of its market value, dropping like a stone during a stretch where the S&P actually gained 6%. The bad news is that SAFM might be headed for another leg lower in the near-term.
Sanderson Farms is currently forming a descending triangle pattern, a bearish price setup that's formed by horizontal support below shares down at $77.50 and downtrending resistance to the upside. Basically, as SAFM bounces between those two technically significant price levels, it's been getting squeezed closer to a breakdown below our $77.50 price floor. If that $77.50 level gets violated, then it's time to sell.
Relative strength, at the bottom of the chart, is an extra red flag in SAFM. That's because our relative strength line has been in a downtrend since shares rolled over 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, Sanderson Farms will keep underperforming the broad market.
This stock looks ugly here, but it becomes toxic with a move below $77.50.
Meanwhile, fast food chain Wendy's (WEN) - Get Report has actually been booking some pretty good gains in the last year or so. Since last April, this $4 billion hamburger chain has rallied 23.6%, outperforming the rest of the market by double-digits. But shareholders might want to think about taking some gains off the table here; Wendy's is showing signs of a top.
WEN has spent the last couple of 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 WEN, that's the $10.50 support level on the chart. Shares are flirting with that $10.50 price level in today's session.
Why all of the significance at $10.50? 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 double top 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 Wendy's shares.
That $10.50 level in WEN 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 $10.50 price in WEN. Once sellers knock out that level, you don't want to own it.
It's not surprising that an energy sector stock has had a rough run in recent months. NOW's (DNOW) - Get Report 10% decline year-to-date may be painful for shareholders, but it's expected considering the whole sector's recent downside. The thing is, there are some other nasty red flags waving in NOW at the moment.
For instance, this stock has essentially been pointed lower since it spun-off from National-Oilwell Varco (NOV) - Get Report last May. And worse, while the rest of the energy sector has been rebounding in the last month, DNOW's move higher has looked anemic by comparison.
The good news is that you don't need to be an expert technical trader to figure out why you don't want to own this stock. The price action is about as simple as it gets. DNOW has been bouncing its way lower in a downtrending channel since last summer, swatted down on every test of the top of the channel. So with shares testing the top of the channel this week, it makes sense to sell the next bounce lower.
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 DNOW.
Iron Mountain started showing some cracks when the calendar flipped to 2015, as shares found support for the second time at the $36 level in February. Then this stock failed to overcome its January highs on the next leg up. That combo is forming a classic reversal pattern in this $8 billion document stock.
Iron Mountain 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 IRM's neckline at $36.
Momentum, measured by 14-day RSI, confirms the downside risk in IRM here. 14-day RSI, our momentum gauge, made lower highs on each peak in the head and shoulders, indicating that selling pressure has been building in spite of the fact that shares are only lingering a bit off of their highs right now.
That's a definite red flag to keep an eye on. If IRM violates our $36 neckline, it's a sell.
We're seeing the exact same setup in shares of French telco Orange SA (ORAN) - Get Report. A strong dollar has been a major challenge for foreign stocks trading on U.S. exchanges, but ORAN has been holding up significantly better than most. That said, the price action is starting to look "toppy" in this $45 billion Paris-based phone and Internet carrier, and that's reason enough to take notice.
Just like IRM, Orange has spent the last several months forming a textbook head and shoulders top. In this case, our neckline is currently coming in at the $15.50 level. In short, if that $15.50 line in the sand gets crossed, then it's time to be a seller.
It's important to remember that you want to be reactionary with this trade. The technicals are a risk-management tool, not a crystal ball. The downside move in ORAN doesn't trigger unless $15.50 gets violated. From there, our price target is prior support down at $13. On the other hand, if shares of ORAN can manage to push above their February highs at $18.50, then the head and shoulders pattern is broken.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.