BALTIMORE ( Stockpickr) -- There's no question about it, the bears have been in charge in 2015. U.S. markets have been in correction mode for the last couple of weeks, selling lower in all but two trading sessions this year. That's about as one-sided as it gets.
But frankly, that's fine. Corrections are a healthy thing for markets to endure -- and this current correction isn't particularly steep from a technical standpoint yet. But while investors don't have much to really worry about at this juncture, that doesn't mean it's a good idea to set your portfolio on autopilot here; if nothing else, this correction is serving as a serious reminder that owning "toxic stocks" can absolutely crush your performance.
And toxic names haven't been hard to find in 2015: as I write, nearly half of the S&P 500 is down 5% or more since the start of the new year. And one-in-ten S&P components is already down double digits. If you want meaningful returns this year, avoiding the worst names is arguably even more important than picking the best ones.
That's why, today, we're taking a closer technical look at five big toxic names to avoid this month.
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.
Companhia Paranaense de Energia
In recent months, investor anxiety has been driving the dollar higher, and that in turn has been shellacking foreign stocks. A perfect example of that comes from Brazilian electric utility Companhia Paranaense de Energia (ELP - Get Report) . Since September, ELP is down nearly 30%. That's pretty dramatic underperformance versus the broad market, and it could just be the beginning.
That's because ELP is currently forming a descending triangle. The descending triangle pattern is formed by horizontal support below shares (at $12 in this case) and downtrending resistance to the upside. Basically, as ELP bounces in between those two technically significant price levels, it's been getting squeezed closer to a breakdown below that $12 price floor. When that support violation happens, we've got our sell signal.
Not surprisingly, relative strength has looked pretty bad in ELP since September. In fact, the relative strength line on the chart has been in a very orderly downtrend over that stretch, an indication that ELP is underperforming in good times and bad ones. As long as that relative strength downtrend remains in force, ELP should continue to trail the S&P in performance.
We're seeing the exact same setup in shares of $12 billion machinery company Pentair (PNR - Get Report) . Like ELP, Pentair has been sold off for the better part of the past year, peaking back in February 2014. But more downside looks likely thanks to another descending triangle setup. A violation of support at $60 is the sell signal in this stock.
Why all of the significance at $50? 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 descending triangle 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 Pentair's shares.
That $60 level in PNR 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. A violation of $60 means that a whole lot of downside risk just opened up in PNR.
$100 billion beverage stock Ambev (ABEV - Get Report) has sold off hard since last April, shedding around 20% of its market value over the course of that stretch. And even though this stock has actually been moving higher in 2015, it doesn't look like the selling is over yet. In fact, shares could be headed much lower. Here's why:
The price action in Ambev is about as simple as it gets -- shares have been bouncing their way lower in a textbook downtrending channel. That channel provides the high-probabiltiy range for shares to stay stuck within, and so, with ABEV touching trendline resistance for a fifth time since April, this stock is likely to see another bounce lower.
The 200-day moving average has been acting like a pretty good proxy for resistance for the past few months -- until ABEV can book a close above that red line, consider the downtrend alive and well. Short sellers should park a protective stop on the other side of that 200-day moving average.
Japanese telecom company NTT Docomo (DCM) is another large-cap foreign stock that's selling off in a pretty basic downtrending channel. In spite of the recent central bank fuelled strength in shares, a test of trendline support looks like a good time to take risk off the table in DCM. Sell the next bounce lower here.
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 DCM.
Don't get thrown off by the abundance of gaps on DCM's chart right now. Those gaps, called suspension gaps, are caused by overnight trading on the London and Tokyo Stock Exchanges. They can be ignored for trading purposes…
Mattress Firm Holding Corp.
Last on our list of toxic names is Mattress Firm Holding Corp. (MFRM) , a small-cap mattress retailer. MFRM is an exception to what we've seen so far in the charts -- in the last 12 months, this stock has actually had some pretty excellent price action, rallying 24%. But shares are starting to look "toppy" here due to a classic reversal setup.
Mattress Firm is currently forming a head and shoulders top, a setup that indicates exhaustion among buyers. The pattern 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 MFRM's neckline at $55. Put simply, if shares violate that $55 line in the sand, then MFRM is a sell.
Momentum is the side-indicator to watch in Mattress firm. 14-day RSI, our momentum gauge, made lower highs on each of the price peaks, an indication that buying pressure is seriously waning in this stock. If $55 gets violated, look out below.
-- 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