Do you own any toxic stocks right now?
Frankly, it hasn't been hard to have exposure to some toxic trades in 2016. After all, while the big S&P 500 index is hovering around breakeven year-to-date, stocks have either been strong performers or miserable ones this year. Very few big-name stocks have price trajectories that look like the S&P.
In fact, as of this writing, approximately 20% of the stocks in the S&P 500 are down 10% or more since the calendar flipped to January. Of those, half are down 15% or worse. And the fact remains that not owning the wrong stocks is arguably more important than owning the right stocks this spring.
The question that investors need to be asking themselves is which stocks are set up to be a drag on performance in the months ahead. And more important: Do you own any of them?
To find the stocks waving red flags here, we're turning to the charts today for a technical look at five big stocks that could be toxic to own.
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.
It shouldn't come as a huge surprise that NetEase (NTES) - Get Report looks toxic right now. This $19 billion Chinese tech stock is one of the bottom rung of stock performers in 2016. So far, NetEase has shed about 22% of its market value this year, making it one of the 15 worst returns in the Nasdaq 100 year-to-date. The bad news is that shares could have even further to fall from here.
NetEase is currently forming a textbook descending triangle setup, a bearish continuation pattern that's formed by horizontal support down below shares at $130, and downtrending resistance to the upside. Basically, as NetEase pinballs between those two technically important price levels, shares have been getting squeezed closer and closer to a breakdown through our $130 price floor. If and when that breakdown happens, we've got a pretty big sell signal on our hands.
Relative strength, which measures NetEase's price performance versus the broad market, is an extra red flag to watch here. Our relative strength line is still holding onto its downtrend from last winter, which tells us that NetEase is continuing to underperform the rest of the market even at this point. Keep a close eye on our $130 line in the sand in the sessions ahead.
Red Hat (RHT) - Get Report is another technology stock that's looking toxic in May. This $13 billion software stock had actually been in rebound-mode for the last few months, rallying about 18% off of its February lows. But after that solid performance, Red Hat is starting to roll over -- and shares are testing a major support level this afternoon.
Since mid-March, Red Hat has been forming a rounding top, a technical price pattern that looks just like it sounds. The rounding top is a bearish reversal setup that signals a gradual shift in control of shares from buyers to sellers. The pattern triggers if the support level at $72 gets violated. Red Hat has been flirting with a breakdown through that level all week, but it's not quite there yet.
Why all of the significance at that $72 level? It all comes down to buyers and sellers. Price patterns, such as this rounding top in Red Hat, 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 of the stock itself.
The $72 support level in Red Hat is a place where there has been an excess of demand for shares; 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 $72 so significant - the move would mean that sellers are finally strong enough to absorb all of the excess demand at that price level. If $72 gets materially busted this week, then Red Hat opens up a lot more downside risk.
Regal Entertainment Group
Regal Entertainment Group (RGC) is another stock that's beginning to look "toppy" after a recent rebound. Regal is up nearly 24% since shares bottomed back in February, but that rally is beginning to show some cracks which means investors in this mid-cap movie theater company might want to think about taking some gains off the table soon. Here's how to trade it.
Regal is currently forming a double top, another simple technical reversal pattern that looks just like it sounds. The double top in Regal Entertainment is formed by a pair of swing highs that topped out at approximately the same price level -- the sell signal comes on a violation of support down at $20. So far, Regal has held up above that $20 price floor. When that changes, we've got a crystal clear sell signal in this stock.
Price momentum is an extra red flag to watch in Regal Entertainment right now. Our momentum gauge, 14-day RSI, has been rolling over, making lower highs over the course of the price setup. That signals a bearish divergence from price that tells us buyers have been quietly fading in this stock. If Genuine Parts suddenly fails to catch a bid above $20 here, look out below.
Casey's General Stores
Things have been pretty straightforward in shares of mid-cap convenience store operator Casey's General Stores (CASY) - Get Report . Since December, this stock has been in a well-established downtrend, selling off nearly 15% in the intervening months. And as shares test the top of their price channel for the fourth time now, it makes sense to sell the next move lower.
The price channel in Casey's General Stores is formed by a pair of parallel trendlines that have corralled most of this stock's price action during that entire stretch. Every test of the top of the channel so far has provided shareholders with an optimal selling opportunity before the subsequent move lower -- and there's no reason to think that shares are going to act any differently this time around.
Waiting for this week's 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 Casey's General Stores.
Last on our list of potentially toxic trades is small-cap semiconductor stock Tower Semiconductor (TSEM) - Get Report . It's been a rough year for shareholders in Tower -- this stock has shed about 22% of its market value in the trailing 12 months, underperforming the broader market by a big margin. The bad news for shareholders is that a technical price pattern points to another potential leg lower in 2016.
Tower has spent most of 2016 forming a head and shoulders top, a classic price pattern that signals 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 Tower's neckline at $11, a price level that's back within grabbing distance this week.
Typically, the head and shoulders pattern comes at the top of a rally, not at the bottom of a stock's recent range, as we're seeing in Tower's chart. That said, even though this pattern may not be textbook, the trading implications are unchanged. If Tower fails to hold a bid at $11, then a void of buying pressure is likely to cause shares to stumble lower in the intermediate-term.
Remember to be reactionary here. Tower's price action doesn't look toxic unless $11 gets violated.
Disclosure: This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.