BALTIMORE (Stockpickr) -- Stocks got shellacked yesterday, reversing the previous two days of upside in one fell swoop. Not surprisingly, the momentum-heavy Nasdaq got hit the hardest with a 3.1% drop. Yes, in case it wasn't already clear, Mr. Market is still in corrective mode this month.
And that's what makes it even more critical than ever to unload the toxic names from your portfolio. Today, I'll show you five big names you need to unload before the next leg down.
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.
Electronic measurement device maker Agilent Technologies (A) has been a strong momentum stock for the last year, rallying more than 31% since this time back in 2013. So it's not a big surprise that it was one of the hardest punished names yesterday, falling more than 2.7% as shareholders looked to take risk off the table.
But the selling looks like it's just getting started thanks to a bearish price setup that's been shaping up for the last three months.
Agilent is forming a descending triangle, a bearish price pattern that's formed by downtrending resistance above shares and a horizontal support line to the downside at $54.50. Basically, as shares bounce in between those two levels, this stock is getting squeezed closer to a breakdown below support. When that happens, we've got our sell signal. Agilent has been flirting with that support level in the last few sessions if it follows through today, then it's time to unload it.
Momentum, measured by 14-day RSI, adds some extra confidence to downside in Agilent this week. Our momentum gauge has been trending lower too since January -- that's a leading indicator for this stock's share price in April.
We're seeing the exact same setup in shares of Fluor (FLR) right now. Like Agilent, Fluor has been forming a descending triangle year-to-date, flashing a warning signal after six months of nonstop market outperformance. The breakdown level to watch in FLR right now is long-term support at $74.
The significance of that $74 level isn't magic. Whenever you're looking at any technical price pattern, it's critical to keep buyers and sellers in mind. Descending triangles 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 $74 support level in FLR 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 $74 gets taken out, you'll want to join sellers in unloading shares.
You don't need to be an expert technical trader to figure out what's going on in Latin American convenience store chain and beverage bottler Femsa (FMX). The setup in shares of this $165 billion firm is about as simple as it gets.
FMX is currently stuck bouncing lower in a downtrending channel. The setup is formed by a pair of parallel trend lines: a resistance line above shares, and a support line below them. Those two lines on the chart provide traders with the high-probability range for FMX's shares to stay within. This week, as FEMSA presses up against to the top of the channel for an eighth time, it makes sense to sell (or even short) its next move lower.
Waiting for that move 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 ensuring that sellers are still in control before you unload your stake in FMX.
Price patterns don't get much cleaner than the one that's been forming in shares of Microsoft (MSFT) -- and now, after rallying more than 37% in the past year, shares of the tech giant are looking "toppy" thanks to a textbook reversal setup.
MSFT is forming a textbook head and shoulders pattern, a bearish reversal setup that indicates exhaustion among buyers. The head and shoulders 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 Microsoft's neckline level at $39.50. That makes MSFT another breakdown that's getting tested in today's session; if shares can't catch a bid back at that price level, it's time to be a seller.
Microsoft's momentum rolled over at the start of April, making a series of lower highs and breaking the uptrend that had been in effect since January. That's an important leading indicator of downside in MSFT right here, but it doesn't become tradable until that $39.50 level gets confirmed today. From here, the next-nearest support level for shares is down at $37.50.
Last up is $36 billion metal component maker Precision Castparts (PCP), a stock that's showing us the exact same setup as the one in MSFT, just much longer-term. PCP's head and shoulders pattern has been forming since the end of October, and that longer-term building phase comes with longer-term trading implications when the breakdown triggers. The key level to watch here is $245. If buyers can't hold PCP at that price, look out below.
Relative strength (not to be confused with RSI) has been egregious for PCP since January. Recall, relative strength is the most important technical indicator when the market is correcting, so PCP's new relative strength downtrend means that for every point the S&P 500 declines, this name is faring even worse.
Sure, the head and shoulders is a well-known price pattern. But that's a big part of this pattern's efficacy: 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."
That's good reason to keep a close eye on MSFT and PCP this week.
To see this week's trades in action, check out the Toxic Stocks portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.