BALTIMORE (Stockpickr) -- This market just doesn't want to stay down. After opening lower yesterday, all three big stock indices managed to push their way to higher ground by the time the closing bell rang. Yes, momentum is clearly on the side of buyers right now.
But this still isn't a "dartboard market." By that, I mean that you can't pick stocks by throwing a dart at a board full of tickers. That may work during truly frothy bull markets, but stock picking still matters in this market.
Case in point, two thirds of Dow Jones Industrial Average components are down year-to-date. And of those, half are down 5% or more since the calendar flipped over to January. They're not just underperforming; they're underperforming by a factor of ten. So, hold onto "toxic stocks" in this environment, and your performance is sure to suffer.
And Dow components are the least of your worries. A handful of other names (even big ones) look even more toxic right now. Today, we'll take a technical look at the ones you should avoid.
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, these toxic stocks are some of the worst positioned names out there 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.
Bank of America
Buying Bank of America (BAC) six months ago would have been a really good move. Shares of the big bank are up more than 14% over that time, stomping the S&P 500's performance over the same time period. But they're looking a whole lot less good now. In the last week, BofA has gone from being solidly in "uptrend" mode to teetering on the edge. Here's how to trade it.
Bank of America is currently forming a very well defined descending triangle pattern, a price setup that's formed by downtrending resistance above shares and horizontal support to the downside at $16. Basically, as shares bounce in between those two levels, they're getting squeezed closer and closer to a breakdown below $16. When that happens, we've got our sell (or short) signal.
It's no coincidence that a breakdown below $16 also means a break in the uptrend that's been in force in BAC since last summer. I'd recommend staying away from the long side of this big bank until it exits the triangle -- one way or another.
MGM Resorts International
MGM Resorts International (MGM) is another name that's been riding momentum highs in recent months. Since August, shares of the casino resort operator are up more than 55%. Shares even added more than 4% to their gains yesterday. But MGM is starting to look "toppy" in February.
MGM is currently forming a double top, a reversal pattern that's formed by two swing highs that top out at approximately the same level. MGM's second top isn't completely formed yet, but that doesn't change how to trade it. A breakdown through support at $23 is the signal that buyers have vacated shares.
Whenever you're looking at any technical price pattern, it's critical to keep buyers and sellers in mind. Triangles and double tops are a good way to quickly describe what's going on in a stock, but they're not the reason it's tradable. Instead, it all comes down to supply and demand for shares.
That horizontal $23 support level in MGM is the spot where there's previously been an excess of demand for shares; in other words, it's a price where buyers have been more eager to step in and buy shares at a lower price than sellers were to sell. That's what makes a breakdown below support so significant. The move means that sellers are finally strong enough to absorb all of the excess demand at the at price level. So if MGM slips below $23, more downside is the high-probability trade.
Vodafone (VOD) isn't far off from the setup in MGM; the $187 billion mobile phone carrier is currently forming a rounding top. Rounding tops look just like they sound; they indicate a gradual shift in control of shares from buyers to sellers. But while the price action at the top may be gradual, the break below support tends to be a lot more abrupt.
For VOD, the breakdown level to watch is $36.
Momentum adds some confidence to the VOD trade. 14-day RSI, our momentum gauge, has been trending lower since shares started topping. That means that down days in VOD have been a lot more forceful than up days since December. The downtrend in RSI is getting tested this week. Based on previous price action, that increases the chances that VOD's share price will be swatted lower in the near-term.
You don't have to be an expert technical analyst to figure out why shares of Morgan Stanley (MS) are starting to look bearish -- the setup in this toxic name is pretty straightforward. Shares of MS have been in a textbook uptrend since this past summer, but the most recent test of trend line support got violated, leaving the financial giant's stock below the channel this week.
That's not out of left field -- all trend lines eventually break sooner or later. And while MS' uptrending price action in the channel was a good reason to own shares for most of the last year, the break is a signal for the most risk-averse owners to start selling. Not surprisingly, most trading signals come in shades of gray that synch up with risk tolerance. For the less risk-averse, shares are still very close to trend line support right now; $29 is the last ditch stronghold for buyers. If MS can't catch a bid at $29, then support in the mid-$20s looks like the next likely stopping point.
Last up is diversified holding company Leucadia National (LUK), a channel trade of a different sort right now. LUK's price channel is in a downtrend, and a very well defined on at that. When it comes to price channels, it's about as simple as it gets: Up is good and down is bad; Leucadia looks the latter. Shares have gotten swatted lower on the last seven tests of trend line support, and they're making their way down the channel in this week's trading.
LUK's relative strength has been anemic in 2014, as sellers drop supply on the market on every fleeting sign of strength. Even though the downside risks are a little better quantified than in the trendline break we saw in Morgan Stanley, LUK's grinding losses aren't showing any signs of stopping.
You don't want to be on the long side of this stock until it pushes through resistance. Until then, this stock looks toxic. Stay far, far away.
To see this week's trades in action, check out the Toxic Stocks portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.