BALTIMORE (Stockpickr) -- Stocks are bouncing hard in the second half of October. Since Monday, the big S&P 500 index has rallied 3.4%, more than doubling the broad market's year-to-date gains. That price action is starkly different from the market scenario we faced a couple of weeks ago.
But don't let your guard down. Despite the recent bounce in the broad market, there are lots of big names that are starting to look "toxic" right now.
Buying big, safe blue chips doesn't make you immune from owning toxic names. In fact, every single name on our list today is a large-cap stock that's worth more than $10 billion in market value. So these aren't just names to avoid buying -- you might already own them today.
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.
There's no two ways about it: 2014 has been a horrible year for shares of Coach (COH) . Year-to-date, shares of this $10 billion handbag maker have fallen more than 36%. And while it might be tempting to pick up shares at lower prices here, the technicals speak to more downside risk ahead.
Coach is currently forming a descending triangle, a bearish price setup that's formed by horizontal support to the downside at $34 and downtrending resistance above shares. Basically, as COH bounces in between those two technically significant price levels, it's getting squeezed closer to that $34 support line. If that level gets broken, then Coach is likely to see prices in the $20s.
Relative strength adds another red flag to the setup in COH. This stock's relative strength line has been in a downtrend since last year, an indication that Coach has been underperforming the S&P since then. As long as the downtrend in relative strength remains intact, Coach's underperformance should continue.
Johnson & Johnson
Health care giant Johnson & Johnson (JNJ) - Get Report is having a much better year than Coach in 2014. Since the calendar flipped to January, shares of this $290 billion health name have rallied more than 12%, but that rally is starting to show some cracks. Here's how to trade it.
Johnson & Johnson is currently forming a broadening top pattern, a bearish reversal indicator that's typically pretty uncommon. With correlations ramping higher in the wake of our recent stock correction, though, we're seeing this setup in quite a few large-cap names this fall. That's not a signal to "run for the hills" just yet, but it is a signal to at least be cognizant of the fact that there's more downside risk in some large-cap names today.
As the name suggests, the broadening top is formed by broadening, or diverging, trend lines. In a nutshell, it indicates growing price volatility, a phenomenon that's linked to correcting markets. So even though JNJ has been moving higher for the last handful of sessions, that volatile bounce isn't a particularly bullish sign. The explicit sell signal comes on a break through the bottom of the pattern, but it's best avoided in the interim as well. Shares can conceivably move much lower and still stay within the price pattern.
We're seeing the exact same setup in shares of Home Depot (HD) - Get Report . Like JNJ, Home Depot is forming a broadening top. The big difference in this $127 billion home improvement retailer is the fact that it's a shorter-term setup. We'll probably see HD resolve its pattern long before Johnson & Johnson does.
The fact that HD is pressing up against the top of its broadening pattern means that shorts will have a low-risk opportunity to bet against HD on this chart's next red candle.
Momentum offers some extra confirmation of a downward move: 14-day RSI has been trending lower since the pattern started forming in August. That's a stretch of time when price was forming higher highs. The fact that those weren't confirmed by momentum creates a situation called a bearish divergence. Buying pressure is waning here, but that's not clear from the new highs that Home Depot is hitting this week.
You don't have to be an expert technical analyst to figure out what's been going on in French telco Orange (ORAN) - Get Report . This chart has been pointing down and to the right since the start of the summer -- and as shares press against the top of their downtrend this week, now looks like another opportunity to sell before the next drop.
Shares of ORAN have been bouncing their way lower in a well-defined downtrend, bouncing in between a pair of parallel trend lines that have marked the high-probability range for shares to stay within. Those five previous tests of resistance have provided pretty predictable selling opportunities for shares of ORAN all the way down. If you're looking for a chance to get out on test number six, it makes sense to wait for the next bounce lower before you 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 ORAN.
Huaneng Power International
Last up is Chinese power company Huaneng Power International (HNP) - Get Report . Despite a 27% rally so far this year, the upside in shares of HNP is starting to show some cracks. The sell signal comes on a move through $42.50.
HNP is currently forming a head and shoulders top, a setup that indicates exhaustion among buyers. The pattern 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 Huaneng Power's neckline at $42.50. One important note is that, because of the down-slope in HNP's neckline, that sell signal moves lower as time progresses. In other words, investors who wait too long to shed shares could be in for a much bigger loss.
Lest you think that the inverse 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 good reason to keep an eye on HNP's breakdown level 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