The scariest thing this Halloween might just be some of the stocks in your portfolio.
It's true that October has been a strong month for stock performance so far. Month to date, the big S&P 500 index is up close to 7%, and the index itself has swung back to breakeven for the year. But this sort of bullish environment is exactly when you don't want to let your guard down.
After all, outperforming the market in 2015 has been every bit as much about not owning the wrong stocks as it has been about owning the right ones. And you don't need to look far to find some large-cap names that are showing cracks this fall. Today, we're turning to the charts to figure out which big stocks to avoid now -- and what price triggers need to get broken for them to go from mere red flags to outright toxic trades.
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 entry and exit points.
So, without further ado, let's take a look at five "toxic" stocks to sell.
Up first on our list today is Netflix (NFLX - Get Report) . This $41 billion streaming video stock has enjoyed a spectacular run in 2015. With shares up more than 99% year-to-date, Netflix's price performance has been good enough to make it the single best performing stock in the S&P 500 index. But that breakneck rally is beginning to show some cracks this fall. And $95 is the line in the sand that signals cause for concern for anyone who owns this stock.
For the last few months, Netflix has been forming a descending triangle pattern, a bearish price setup that's formed by horizontal support down below shares (in this case at our aforementioned $95 level), and downtrending resistance to the upside. Basically, as shares of Netflix have bounced in between those two price levels since the start of August, shares have been getting squeezed closer and closer to a breakdown below our support line. When that happens, we've got a sell signal.
Typically, the descending triangle is a continuation pattern, not a reversal pattern like we're seeing in Netflix's case. Nevertheless, while this pattern may not be "textbook", the trading implications are exactly the same if $95 gets violated.
Relative strength, which measures Netflix's price performance versus the broad market, is an extra red flag to watch here. As this big stock has outperformed, relative strength has been making its way higher in a well-defined uptrend -- but that uptrend got broken with last week's prolonged underperformance. That's a signal that Netflix could be ready to mean-revert and underwhelm investors in the final stretch of 2015.
We're seeing the same setup in small-cap poultry stock Sanderson Farms (SAFM - Get Report) -- with the big difference that this descending triangle trade looks more textbook than the one in Netflix. This isn't the first time Sanderson Farms has made our list of potentially toxic stocks; since we last looked at another downside setup in shares back in April, Sanderson has shed about 15% of its market value. That's good reason to heed the warnings that we're seeing this fall.
The big price level to watch here is support at $65.
Why all of the significance at that $65 level? It all comes down to buyers and sellers. Price patterns, such as this descending triangle pattern in Sanderson Farms, are a good quick way to identify what's going on in the price action, but they're not the actual reason a stock is tradable. Instead, the "why" comes down to basic supply and demand for Sanderson's shares.
The $65 support level is a price where there has been an excess of demand for shares; in other words, it's a spot where buyers have previously been more eager to step in and buy than sellers have been to take gains. That's what makes a breakdown below $65 so significant -- the move means that sellers are finally strong enough to absorb all of the excess demand at that price level.
Like with any breakout trade, it's important to be reactionary here; big downside in Sanderson Farms doesn't become a high-probability trade until sellers are able to knock this stock below our $65 support level for a sustained period.
Palo Alto Networks
Network security stock Palo Alto Networks (PANW - Get Report) has enjoyed a strong run in 2015. Since the start of January, shares of this cyber security play have rallied about 35%, compared with a slightly negative run in the S&P 500. That's some pretty substantial outperformance. But if you own this stock right now, you may want to consider taking some gains off the table here. That's because Palo Alto Networks is currently testing a major support level at $160 this week.
Palo Alto Networks is currently forming a double top pattern, a bearish reversal setup that looks just like it sounds. The double top in shares is formed by a pair of swing highs that peak at approximately the same price level; the sell signal comes on a violation of the trough that separates those two price highs. For Palo Alto Networks, that's support down at $160.
The side indicator to watch right now in Palo Alto Networks is momentum. Our momentum gauge, 14-day RSI, has been rolling over, making lower highs on the price action's pair of peaks. That's an indication that down days are outpacing up days in this stock. If $160 gets broken, then this outperformer becomes a sell.
At first glance, it may seem like Verizon (VZ - Get Report) isn't trailing the market too badly. Shares are down in 2015, but only by 1.9% year-to-date. That's a misleading stat, though. You see, Verizon's chart reveals that shares made a major trend reversal back at the beginning of the summer. Since then, this stock has actually shed almost 9% of its market value, a big move for a nearly $200 billion stock.
Since May, Verizon has been bouncing its way lower in a well-defined downtrending channel. The firm's downtrend is formed by a pair of parallel trend lines that identify the high-probability range for shares of this stock to remain stuck within. Every test of the top of this stock's price channel has been a great selling opportunity so far, and shares are pressing up against that trendline resistance level again this week – from here, it makes sense to sell the next move lower.
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 contrarians will 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 Verizon.
Last up on our list of potentially toxic stocks is drug maker Eli Lilly (LLY - Get Report) . Eli Lilly has looked pretty attractive from a technical standpoint all year long, climbing 30% higher from its starting point in January to its peak back in September. But the rally is in jeopardy now, thanks to a major support violation that's getting tested in today's session.
Lilly is currently forming a rounding top, another one of those bearish reversal patterns that looks just like it sounds. The rounding top indicates a gradual transition in control of shares from buyers to sellers, and it triggers on a violation of the support level that acts as a floor during the pattern. For Eli Lilly, that key breakdown level is $77.50, a price that got violated this week.
For now, Lilly's shares are consolidating right below our $77.50 price level, close enough that it's still a little early to call the breakdown triggered. At this point, the support violation is too small to be considered material. That said, the next couple of sessions are going to say a lot about this stock's trajectory. If Lilly fails to re-enter the pattern here, look out below.