5 Car Stocks to Trade for Gains in May


BALTIMORE (Stockpickr) -- Investors have been spinning their tires for the past two full months now, slugging sideways in a market that's been a big departure from the straight up environment that market participants became accustomed to in 2013.

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The only cure for that churn has been to focus on specific sectors that have escaped it. Look at the year-to-date performance across different industries, and it's clear that we're still in a stock picker's market. And as we approach the start of May trading, the automotive sector is showing some big technical signs of strength.

That's why we're taking a look at five car stocks to trade for gains in the month ahead.

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.

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Without further ado, let's take a look at five technical setups worth trading now.

Ford Motor

First up is $63 billion automaker Ford Motor (F), a name that hasn't exactly been a big performer in the last six months. Since late October, Ford's shares have dropped by more than 9%, underperforming the broad market by a big margin. But a major change in trend is shaping up in Ford this spring -- and we're coming up on a big buying opportunity.

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Ford is currently forming an inverse head and shoulders pattern, a classic technical setup that indicates exhaustion among sellers. The pattern is formed by two swing lows that bottom out around the same level (the shoulders), separated by a bigger trough called the head. The buy signal comes on the breakout above the patterns neckline level, currently right at $16.50. Ford's pattern isn't textbook -- or particularly pretty, for that matter -- but that doesn't change the trading implications from a $16.50 breakout. That's our high-probability buy signal in Ford, and shares are within grabbing distance this week.

Momentum adds some confidence to the staying power in Ford's breakout -- 14-day RSI has been making higher lows over a stretch when price has been flat. Since momentum is a leading indicator of price, that momentum uptrend bodes well for Ford buyers.

Tata Motors

Indian automaker Tata Motors (TTM) is the single best-looking major automaker from a technical standpoint right now, and you don't need to be an expert technical analyst to see why. TTM's price setup is about as simple as they get.

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Tata Motors is currently bouncing higher in an uptrending channel, a move that's setting up a textbook buying opportunity this week. TTM's channel is bounded by resistance above shares and trend line support below them; those two parallel trend lines provide a high probability range for shares of this stock to trade between. And so, as shares bounce off of trend line support for a fourth time, it makes sense to be a buyer here.

Waiting for a meaningful bounce off of support is crucial for two big reasons: It's the spot where shares have the furthest to move up before they hit resistance, and it's also the spot where the risk is the least (because shares have the least room to move lower before you know you're wrong). Remember, all trend lines do eventually break, but by actually waiting for the bounce to happen first, you're ensuring TTM can actually still catch a bid along that line before you put your money on shares.

Finally, relative strength, on the lower subchart, looks solid for Tata Motors right now. Not only is this name trending higher, it's also outperforming the broad market every step of the way. If you decide to be a buyer here, I'd recommend keeping a protective stop at the 50-day moving average.


$10 billion auto dealer CarMax (KMX) has been a miserable performer in 2014 -- since the calendar flipped to January, shares of KMX have dipped more than 8%. And a quick glance at the chart makes it look like the selling isn't about to let off anytime soon. But the setup in KMX isn't what it appears -- a change in trend looks forthcoming.

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KMX has been trending lower since last fall, bouncing between a pair of trend lines all the way down. But the notable thing in CarMax is the fact that those trend lines have been converging, so unlike a typical trend channel, the KMX trade is actually a reversal setup called a "falling wedge." This pattern has historically been a significant setup to watch -- one study puts the falling wedge's ability to spot a reversal at more than 90%. The buy signal comes on a breakout above resistance, a level that CarMax will take some time to retest.

Patience is a virtue on this trade. Obviously, KMX could fall materially further and remain within the wedge before a breakout does happen. When and if shares break above resistance, I'd recommend keeping a protective stop on the other side of CarMax's 200-day moving average.

Allison Transmission Holdings

The outperformance in $5.4 billion auto parts stock Allison Transmission Holdings (ALSN) has been a little more obvious lately. In the last six months, ALSN has rallied more than 18%, outperforming the S&P 500 by a factor of 3. And while shares have stayed sideways since the start of February, that's actually the setup that's creating a trading opportunity in shares this week.

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Allison is currently forming a rectangle pattern, a price setup that's formed by a horizontal resistance level above shares at $31, and another horizontal support level down at $28.50. The rectangle gets its name because it essentially "boxes in" shares. The high-probability trade comes when ALSN exits its channel. A move through $31 is a buy signal, whereas a drop below $28.50 is a signal to sell.

Typically, rectangles are continuation patterns; that means that they tend to resolve in the same direction as the preceding trend. So since ALSN's trend was heading higher heading into the rectangle, an upside breakout through $31 is the most likely outcome from here. Wait for that move to happen before jumping into shares.


We're seeing the exact same setup in shares of small-cap OEM parts manufacturer Meritor (MTOR). Like Allison, Meritor is consolidating sideways in a rectangle after a big move higher. The topside resistance level to watch in MTOR is $13.

Why is $13 so significant? It all comes down to buyers and sellers. Price patterns like rectangles are a good quick way to identify what's going on in the price action, but they're not the reason a stock is tradable. Instead, the "why" comes down to basic supply and demand for Meritor's stock.

The $13 resistance level, for instance, is a price at which there has been an excess of supply of shares; in other words, it's a place at which sellers have previously been more eager to step in and take gains than buyers have been to buy. That's what makes a breakout above $13 so significant -- the move means that buyers are finally strong enough to absorb all of the excess supply above that price level.

Don't put money on this trade until the breakout happens.

To see this week's trades in action, check out the Technical Setups for the Week portfolio on Stockpickr.

-- Written by Jonas Elmerraji in Baltimore.





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At the time of publication, author had no positions in stocks mentioned. Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation. Follow Jonas on Twitter @JonasElmerraji

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