Nothing scares income investors like a dividend trap.
Dividend traps are high-yield stocks that boast unsustainably high dividend payouts. On paper, they look like attractive income investments, but in reality, the high likelihood of a dividend cut would be catastrophic for share prices. A recent article pointed out three popular dividend traps and recommended selling them.
But not so fast. When it comes to investing, timing is everything. And most investors would probably agree that it's a good idea to hang on to an overpriced stock as long as that hefty price tag keeps going higher until you sell it.
Just like income investors shouldn't look solely at dividend yield, it's a huge mistake to ignore what's happening on the tape. After all, there are plenty of examples of "dividend traps" from a few years ago that have gone onto post substantial rallies in the intervening years.
To figure out the timing on these three dividend traps, we're turning to the charts for a technical look.
First, a quick note on the technical toolbox we're using here: Technical analysis is a study of the market itself. Since the market is ultimately the only mechanism that determines a stock's price, technical analysis is a valuable tool even in the roughest of trading conditions. Technical charts are used every day by proprietary trading floors, Wall Street's biggest financial firms, and individual investors to get an edge on the market.
Here's why you should wait to sell three popular dividend traps.
We'll start off with shares of CenturyLink(CTL) - Get Report . This $14 billion stock currently pays an 8% yield, but since shares peaked back in April, CenturyLink has given a whole lot more than that back, sliding nearly 18% lower in five weeks. But that doesn't mean it's time to sell. Instead, this stock looks like it's showing traders a buyable dip after the last month's correction.
CenturyLink has actually been very technically obedient in 2016. Shares broke out of an inverse head and shoulders setup in February, rallying more than 45% from trough to peak. And after correcting hard from late April, shares are finally catching a bid again at the exact same trend line that spurred February's move up.
Put simply, if CenturyLink can stage a bounce through $27, shares are likely to retest prior highs at $32 this summer.
(Otherwise, if CenturyLink violates $26, sellers are back in control and it makes sense to sell it.)
Dividend trap or not, it's hard to argue with the price action in Chimera Investment(CIM) - Get Report lately. This $2.8 billion REIT has paid investors total returns of approximately 17% so far in 2016, leaving the broad market in its dust. And shares look positioned for a second leg higher in June.
Chimera is currently forming a bullish continuation setup called an ascending triangle. Resistance up at $15 is the big breakout level to watch here; if shares can push through $15, then more upside becomes likely. At the same time, relative strength, which measures Chimera's price performance versus the rest of the stock market, has been holding onto its uptrend, signaling that this stock is still outperforming right now.
Unless Chimera violates support at $14, it makes sense to keep holding this 12.8% yielder.
Rounding out our list is $129 billion banking giant HSBC Holdings(HSBC) - Get Report . HSBC started off 2016 like the rest of the financial sector: in free fall. But long-suffering shareholders could be in store for a reprieve this summer thanks to a classic reversal setup that's been forming in shares since January. HSBC's inverse head and shoulders pattern triggers a breakout buy signal with a move through its neckline up at $34.50.
Price momentum confirms HSBC's bullish trajectory. Our momentum gauge, 14-day RSI, has been making slightly higher lows on each of this stock's price lows. That's a bullish divergence that indicates buying pressure is building in this stock. As long as HSBC holds out above $30, it makes sense to keep owning it.
Disclosure: This article is commentary by an independent contributor. At the time of publication, portfolios managed by the author were long TSLA.