BALTIMORE ( Stockpickr) -- Which stocks should I buy? It's the eternal question that most investors spend most of their time wondering. But is it the wrong question?
More so than any other year since 2008's market crash, 2014 has been a year for stock pickers. That's because, as the end of the calendar year creeps closer, one in three S&P 500 components is actually down since January. And considering the fact that the big index is up more than 10% year-to-date, those underperformers are missing the mark by a big margin. In a big way, knowing which stocks not to buy has almost been more important for your ability to book gains in 2014 than knowing which ones you should.
That's why we're taking a closer technical look at five "toxic stocks" to sell this week.
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
So, without further ado, let's take a look at five "toxic stocks" you should be unloading.
Advanced Semiconductor Engineering
We're starting things off with Advanced Semiconductor Engineering (ASX - Get Report) , a Taiwan-based chipmaker. Overwhelmingly, overseas stocks have been lagging the broad market here at home -- but that hasn't been the case at Advanced Semiconductor. In fact, this $10 billion chip stock is up more than 30% since the calendar flipped to January. But investors should think about taking their gains here; ASX is starting to look toxic for your portfolio.
That's because ASX is currently forming a descending triangle pattern, a bearish price setup that's formed by downtrending resistance above shares, and horizontal support to the downside at $5.80. Basically, as ASX bounces in between those two technical price levels, it's getting squeezed closer to a breakdown below its $5.80 price floor -- if that line in the sand gets violated, then Advanced Semiconductor is a sell.
For short sellers, the most recent high at the $6.40 level is a logical place to park a protective stop.
Medical equipment maker ResMed (RMD - Get Report) is another name that's starting to look "toppy" after a bullish start to the year. RMD has more or less kept pace with the S&P 500 in 2014, climbing just over 11% from January to today -- but shares started forming a long-term triple-top over the summer, and that setup is getting close to completion this fall.
It's worth noting that long-term price setups come with equally long term trading implications when they trigger.
The triple-top that RMD is showing is a fairly rare pattern, but the trigger is pretty perfunctory: if shares break down below support at $48, then sellers are in control, and it's time to unload them. Downside isn't a foregone conclusion in ResMed, but this setup only gets invalidated if shares can close above their prior highs at $54.
Momentum is the side-indicator to watch in RMD: 14-day RSI has been making lower highs during each of the price peaks of the triple top. That bleed in our momentum gauge tells us that selling pressure is still mounting in this stock.
A similar setup is shaping up in shares of mid-cap Chinese internet stock Bitauto Holdings (BITA - Get Report) . BITA is forming a double-top, a more common topping patten that looks just like it sounds. The double-top in BITA is formed by a pair of swing highs that peak at approximately the same resistance level ($95 in this case). The sell signal comes on a drop below the trough at $65 that separated those highs.
If $65 gets violated, then look out below.
Why all of the significance at $65? It's not magic. Whenever you're looking at any technical price pattern, it's critical to keep buyers and sellers in mind. Patterns like the double or triple-top 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 BITA's shares.
That $65 level in Bitauto 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.
As energy commodity prices have sold off in recent months, so too have the E&P stocks that pull those resources out of the ground. And Ultra Petroleum (UPL - Get Report) has been no exception. The good news is that you don't need to be an expert technical trader to figure out why this stock looks toxic here -- the setup in shares of Ultra Petroleum is about as simple as they get.
UPL is bouncing its way lower in a textbook downtrending channel, a price setup that's formed by a pair of parallel trendlines that have kept UPL range-bound since April. The price channel in UPL identifies the high-probability range for shares to stay within, and so, with shares pressing up against resistance for the eighth time since this price channel kicked off, it makes sense to be a seller on the next bounce lower.
Relative strength adds another red flag to the setup in Ultra Petroleum. This stock's relative strength line is trending down just like its price, which means that UPL is underperforming the broad market here. As long as the downtrend in relative strength remains intact, UPL's underperformance should continue.
Last up on our "toxic stocks" list today is Kennametal (KMT - Get Report) , an industrial tool company that's sold off more than 23% since the beginning of the year. Like UPL, Kennametal is bouncing its way lower in a textbook downtrending price channel. That means that the high-probability trade is to sell the next bounce down.
Waiting for that bounce lower 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 confirming that sellers are still in control before you unload shares of KMT.
The 50-day moving average has been a good proxy for resistance since this summer -- the fact that it's accelerating lower here doesn't bode well for Kennametal owners. This stock is likely to keep up its underperformance in the near-term.
To see this week's trades in action, check out the Toxic Stocks portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
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 that 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