BALTIMORE (Stockpickr) -- Stocks got gut-punched with the third-worst trading session of 2014 yesterday, the S&P 500 handing back 1.17% by the close.
Escalations in the Ukraine and a slowdown in China took the blame for Thursday's meltdown, but the warning signs were really in place a whole week ago. With the broad market pressing against the top of the channel that it's been bouncing within for the last 15 months, a move lower was the high-probability outcome heading into this week. More important, stocks look likely to continue a correction for the rest of March.
That's not a death sentence for your portfolio. We're still in a "buy the dips market," after all. Well, if you don't own any "toxic stocks," that is -- toxic stocks that could crush your portfolio's performance as the market takes a breather this month.
So which names do you need to avoid? Today, we're taking a technical look today at five toxic stocks you should start selling.
Just to be clear, 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, 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.
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.
First up is Western Digital (WDC), the $20 billion hard drive maker. The last year has been spectacular for investors in WDC; this stock is up more than 76% in the previous 12 months, besting the S&P's impressive performance by a factor of almost four. But none of that matters now. This highflier is looking "toppy" in 2014.
WDC is forming a textbook double top, a bearish reversal pattern that looks just like it sounds. The double top is formed by a pair of swing highs that max out at approximately the same price level. The sell signal comes when the trough that separates the two highs gets violated. For WDC, that breakdown level is right at $82.50. A drop below $82.50 means that it's time to be a seller (or go short).
Momentum, measured by 14-day RSI, adds some extra evidence to downside in WDC. While this stock has lingered with a price ceiling at $90, our momentum gauge has been making lower highs. If shares fail to hold a bid at $82.50, expect the correction to be a lot bigger than the one in the broad market.
Melco Crown Entertainment
We're seeing the exact same setup in shares of $23 billion Macau gambling stock Melco Crown Entertainment (MPEL). Like Western Digital, MPEL is forming a double top pattern after a big move higher in the past year. In this case, shares MPEL have doubled over those trailing 12 months.
Now the breakdown level to watch for comes in at $38. If shares slip below it, we've got a sell signal.
There's no magic in why $38 is such an important price level. Whenever you're looking at any technical price pattern, it's critical to keep buyers and sellers in mind. 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 $38 support level in MPEL 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.
There's still some semblance of support at the 50-day moving average, which is why it's key to wait for the $38 breakdown before unloading MPEL.
Small-cap REIT Potlatch (PCH) has been less of a standout performer lately, with shares down double digits in the last year. But the selling may be only just getting started in this $1.6 billion timer stock. Here's how to trade it.
Potlatch is currently forming a descending triangle pattern in the long-term. The setup is formed by a horizontal support level below shares at $37.50 and downtrending resistance to the upside. Basically, as shares bounce between those two important technical levels, they're getting squeezed closer and closer to a breakdown below support at $37.50. When that happens, it's time to be a seller.
Relative strength (not to be confused with RSI), has been anemic in shares of PCH. With the market correcting this month, relative strength is the single most important indicator you can have in your toolbox; that's what makes the downtrend in relative strength all the more serious in PCH. This name isn't losing its toxicity anytime soon.
Compania Cervecerias Unidas
You don't have to be an expert technical analyst to figure out why Chilean brewery stock Compania Cervecerias Unidas (CCU) -- also known as United Breweries -- is looking toxic right now. A quick glance at the chart should be good enough to keep most investors away.
CCU is currently in a downtrending channel, a well-defined range that shares are likely to stay within. When it comes to price channels, the analysis is about as simple as it gets: Up is good and down is bad. And so CCU isn't looking very good right now. As shares bounce off of trend line resistance for a fourth time since last summer, it makes sense to be a seller here.
While it may be tempting to pick up shares of a name like CCU from a value perspective, value investors need to heed the words of Ben Graham: "In the short-term, the market is a voting machine." Well, the votes are cast, and at the moment, CCU is failing every attempt at catching a bid.
Shares may be cheap now, but they look likely to get cheaper from here. I'd stay away from the long-side until shares are able to hold 50-day moving average for two consecutive sessions.
Last up is The Buckle (BKE), another stock that's forming a textbook downtrend right now. Like with CCU, a bounce off of trend line resistance is giving traders a big sell signal in this apparel stock. This week's bounce is the operative word here without it, the sell signal in BKE wouldn't be nearly as emphatic.
Waiting to sell off a resistance bounce makes sense 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 ensuring that sellers are still in control before you unload your stake in BKE.
But, to be clear, sellers are in control. Now is your chance to unload before shares touch trend line support again.
To see this week's trades in action, check out the Toxic Stocks portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.