The buyers are back in town -- sort of. Stocks have spent most of this week rebounding, even counting Thursday's small decline. Despite Monday's market closure for President's Day, the big S&P 500 index has already managed to move almost 3% higher this week, making it the best single-week performance for stocks so far in 2016 before today's price action gets factored in.
Of course, that's not exactly a high bar to hit.
And it's a little early to sound the "all clear" for buying stocks again, though it is worth noting that nearly every name in the S&P 500 actually participated in the rally. Approximately 93% of S&P components are up so far this week -- which means that 7% of S&P components aren't participating in the rebound this week.
In short, no matter which way the market ends up this month, a small number of stocks could be "toxic" for your portfolio right now. And avoiding them could make all the difference for your stock market performance in 2016.
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.
Up first is United Technologies(UTX) - Get Report . This big industrial manufacturing firm has been trailing the broad market by a noticeable margin so far in 2016 -- but it's the potential downside that's still left in shares that investors need to pay attention to right now. Here's how to trade it.
United Technologies is currently forming a descending triangle pattern, a bearish continuation pattern that's formed by horizontal support to the downside (at $85 in this case) and downtrending resistance above shares. Basically, as United Technologies bounces between those two technically significant price levels, shares have been getting squeezed closer and closer to a breakdown through our $85 price floor. When that happens, we've got our sell signal.
Relative strength, which measures United Technologies' price performance vs. the broad market, is an extra red flag to watch here. Our relative strength line is still holding on to its downtrend from the beginning of last year, which tells us that this stock is still underperforming the rest of the market in the long-term. If $85 gets busted, look out below.
Dominion Midstream Partners
We're seeing the same price setup in shares of midstream energy stock Dominion Midstream Partners (DM) . Like United Technologies, Dominion is forming a textbook descending triangle pattern in the long-term. For Dominion Midstream, the key breakdown level to watch is support down at $25.
Why all of the significance at that $25 level? It all comes down to buyers and sellers. Price patterns, such as this descending triangle in Dominion, are a good quick way to identify what's going on in the price action, but they're not the actual reason a stock is tradable. Instead, the "why" comes down to basic supply and demand for shares.
The $25 support level is a price at which there has been an excess of demand for shares; in other words, it's a spot where buyers have previously been more eager to step in and buy shares than sellers have been to take gains. That's what makes a breakdown below $25 so significant -- the move would mean that sellers are finally strong enough to absorb all of the excess demand at that price level. Keep a close eye on that $25 level this month.
Apparel retailer Gap(GPS) - Get Report is showing investors some strong performance in 2016. Since the start of the year, this $11 billion stock has moved 6% higher, leaving the rest of the S&P 500 in its dust. But zoom out on Gap's chart a bit, and things don't look so rosy anymore. In fact, they look downright toxic.
Long-term, Gap has been sliding lower -- but its selloff has looked orderly since this past fall, when shares entered a well-defined downtrending channel. The trend channel in Gap is about as simple as a technical price pattern gets. The pattern is formed by a pair of parallel lines that have corralled the price action for this stock going back to October. In short, every test of the top of the price channel has created a big selling opportunity in shares of Gap -- and the stock is bumping its head on that resistance level for a fifth time this week.
From here, it makes sense to wait and see what happens next. If Gap bounces lower, then we've got a strong sell signal, and this stock is likely to give back all of its 2016 gains pretty quickly. It makes sense to stay away from the long-side of Gap until shares can start making some higher highs and lows.
Liberty Global(LBTYA) - Get Report is showing investors a very similar setup to the one in Gap right now. This $9.4 billion cable network operator has been selling off since the beginning of last year, backsliding more than 36% since its May highs. All the while, a downtrending channel has provided market participants with a pretty clear look at where shares were likely headed: down and to the right.
Liberty Global has been rebounding hard this week, but the price action looks more like a relief rally in the context of a downtrend. As shares approach trendline resistance, it makes sense to sell the next bounce lower in this stock.
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 contrarians will 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 Liberty Global.
DG has been a pretty strong performer for the last several months now. Since shares bottomed back in mid-November, this stock has been rallying, boosted by investor concerns of a possible recession. In the last three months, Dollar General has added more than 20% onto its market value. But now might be the time to start thinking about taking some gains off the table in this stock. Shares are starting to look "toppy," thanks to a classic reversal setup.
Dollar General is forming a head and shoulders top, a classic price pattern that signals 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 Dollar General's neckline -- that's the $68 price level.
There's good reason to pay attention to this particular price action in Dollar General right now: 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." If DG violates $68, it's a sell.
Disclosure: This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.