After the bullish run stocks have enjoyed for the last year and change, you'd better get your guard up.
Not because it looks like the broad market is getting ready to end its trend -- the bullish bent to U.S. markets looks alive and well as I write. Instead, it's because, despite the tailwind for stock prices, a very big chunk of this market hasn't been participating in the upside.
In short, simply avoiding the worst-performing stocks in 2017 could boost your returns far more than owning the very best ones.
So, to figure out which stocks you should be avoiding as we close out the year, we're turning to the charts for a technical look at five that could be about to turn toxic.
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.
Just so we're clear, the companies I'm talking about today are hardly junk.
By that, I mean they're not next up in line at bankruptcy court - and many of them have very strong businesses. But that's frankly irrelevant to what happens to their stocks; 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.
So without further ado, let's take a look at five toxic stocks to sell -- and when to sell them.
Up first on the list is alcoholic beverage company Brown-Forman (BF.B) . Put simply, Brown-Forman has totally missed out on this year's rally: In the trailing 12 months, shares of BF.B are down 7.7% on a price basis, underperforming the S&P 500 by 25.26%. The bad news for Brown-Forman shareholders is that this stock could be heading even lower in the near term.
That's because Brown-Forman has spent the last few months forming a descending triangle pattern, a bearish continuation setup that signals the possibility of more downside ahead for this stock. The descending triangle is formed by a horizontal support range below shares, paired with downtrending resistance to the top-side. Basically, as Brown-Forman has pinballed in between those two technically important price levels, shares have been getting squeezed closer and closer to a breakdown through the bottom of their support range at $44.
If BF.B violates $44, look out below.
This stock has an extra red flag showing up in the form of relative strength, the indicator down at the bottom of the price chart. Relative strength has been making lower highs in Brown-Forman since last February, indicating that underperformance is continuing to plague shares in 2017. Buyer beware.
We're seeing the exact same setup in shares of Bio-Techne (TECH) - Get Report, a $4 billion biotechnology reagent and instrument supplier. Bio-Techne peaked back in July, and shares have been pointed lower ever since, shedding 12% of shares' market value in the process. Now, a textbook descending triangle setup is pointing this stock lower. For Bio-Techne, the sell comes on a violation of $98 support.
What makes that $98 level in particular so significant for TECH? It all comes down to buyers and sellers. Price patterns, like this descending triangle, are a good quick way to identify what's going on in the price action, but they're not the actual reason it's tradable. Instead, the "why" comes down to basic supply and demand for shares of the stock itself.
The $98 support level in Bio-Techne is a place where there has been an excess of demand for shares since November; in other words, it's a spot where buyers have been more eager to step in and buy shares than sellers have been to take gains. That's what makes a breakdown below $98 so significant - the move means that sellers are finally strong enough to absorb all of the excess demand at that price level.
Bottom line: If TECH trades below $98, it becomes a sell.
The last few months have brought some solid upside to shareholders in telecom giant AT&T (T) - Get Report. Since the middle of November, AT&T has rallied almost 14% higher, beating the rest of the S&P 500 by more than double. But investors might want to think about taking some gains off the table in AT&T here - this stock is starting to show some cracks in February.
AT&T 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 top out at approximately the same price level. Those peaks are separated by a low that identifies the breakdown level for the pattern; in AT&T's case, that sell signal comes on a dip below $40.50.
Price momentum, measured by 14-day RSI in AT&T's chart above, is an extra red flag to pay attention to in this price setup. That's because our momentum gauge rolled over in December, making lower highs on the pair of peaks that make up the double top pattern. Momentum is a leading indicator to price, and the lower peaks create bearish confirmation that suggests buying pressure is waning here. If $40.50 gets violated, AT&T becomes predisposed for a correction.
After ended 2016 at new 52-week lows, some investors might be thinking that First Solar is offering a bargain. But that's a mistake. First Solar's downtrend is alive and well this winter - and that means investors should steer clear until the primary trend changes in this stock.
The downtrend on First Solar's chart is about as simple as price patterns get. The setup is formed by a pair of parallel trend lines that have swatted shares of FSLR lower on every attempt to break free of them so far. That means, as shares come off their fifth test of trendline resistance in 2017, it makes sense to be a seller. The resistance bounce back in January is the sell signal to pay attention to here.
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 First Solar.
When we last looked at PSX, shares were looking "toppy" following a respectable rally from its summer lows. The pattern in play was a head and shoulders top, a classic reversal setup that started forming back in mid-November. The head and shoulders pattern is identified by two swing highs that top out at approximately the same level (the shoulders), separated by a higher high (the head). $82 was the line in the sand that, if violated, signaled more downside risk ahead.
Sure enough, PSX violated $82 just a couple of trading sessions later, opening up downside risk along the way. The question now is how to trade it.
The answer has everything to do with Friday's fourth-quarter earnings call. As of this writing, it's too early to say how Wall Street is going to react to PSX's earnings during the full session -- but it's certainly a big enough catalyst to change shares' trajectory here if they're positive. That said, the combination of a violation of $82 support and negative earnings reaction make the risks high on the other side of the trade.
Buyers waiting for an entry opportunity should continue to steer clear until the dust settles in Phillips 66.
At the time of publication, author had no positions in the stocks mentioned.