It's time to get defensive. Even though the bulls appear to be back in control of U.S. markets this spring, not owning the "wrong" stocks could have more to do with your portfolio's performance than owning the "right" ones.
That's already been playing out in a big way within the broad market indices in 2016. While the S&P 500 continues to trade around breakeven for the year, nearly a fifth of the stocks that make up the big market index are down 10% or more year-to-date. In short, a pretty big chunk of the market is effectively punishing anyone who owns them right now.
And even though the big picture still looks attractive for stock market investors at this point, a small contingent of stocks is looking "toxic" in April. To find the stocks waving red flags right now, we're turning to the charts today for a technical look at five big stocks that could be toxic to own.
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.
Just so we're clear, the companies I'm talking about today are hardly junk. By that, I mean they're not next up in line at bankruptcy court -- and many of them have very strong businesses. But that's frankly irrelevant to what happens to their stocks; 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.
So without further ado, let's take a look at five "toxic stocks" to sell.
Teva Pharmaceutical Industries
Leading off our list today is $59 billion drug maker Teva Pharmaceutical Industries (TEVA - Get Report) . Teva has been a conspicuous underperformer lately. Since the calendar flipped to 2016, this pharma stock has shed about 14% of its market value. The bad news for shareholders is that Teva could actually have even further to fall thanks to a bearish price setup in shares.
Teva is currently forming a descending triangle pattern, a bearish continuation setup that's formed by horizontal support down below shares at $54, and downtrending resistance to the upside. Basically, as Teva bounces between those two technically important price levels, shares have been getting squeezed closer and closer to a breakdown through our price floor at $54. If that $54 level gets violated, look out below.
Relative strength, which measures Teva's price performance versus the broad market, is an extra red flag to watch here. Our relative strength line is still holding onto its downtrend from the start of the year, which tells us that Teva is continuing to underperform the rest of the market right now. Investors should keep a close eye on the $54 level this month.
We're seeing the exact same price setup in shares of embattled renewable energy utility TerraForm Power (TERP - Get Report) . TerraForm has been making headlines thanks to its relationship with SunEdison (SUNE) , but this is the chart that investors should be paying attention to. Like Teva, TerraForm is currently forming a descending triangle pattern after a long-term price rout. The key support level to watch here comes in at $7.50…
Why all of the significance at that $7.50 level? It all comes down to buyers and sellers. Price patterns, like this descending triangle in TerrraForm Power, 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 shares of the stock itself.
The $7.50 support level in TerraForm is a place where there has previously been an excess of demand for shares; in other words, it's a spot where buyers have been more eager to step in and buy shares than sellers have been to take gains. That's what makes a breakdown below $7.50 so significant -- the move would mean that sellers are finally strong enough to absorb all of the excess demand at that price level. Until this stock can start making some higher lows and highs, it makes sense to stay away from the long-side.
Royal Bank of Canada
Royal Bank of Canada (RY - Get Report) has managed to shake off the poor performance that its U.S.-based peers have experienced in 2016. So far this year, RBC is up about 5%, besting the nearly 8% decline in the rest of the financial sector. But investors might want to think about taking some of those gains off the table this spring -- RBC is starting to look "toppy" in the short term.
RBC is currently forming a double top pattern, a bearish reversal setup that looks just like it sounds. The double top is formed by a pair of swing highs that peak at approximately the same price level. The sell signal comes on a breakdown below the bottom of the trough that separates those two peaks. For Royal Bank of Canada, that important support level to watch is $56, a price level that's getting tested this week. If shares materially violate $56, then RBC opens up its downside risk.
In the meantime, downside in RBC isn't a foregone conclusion yet. If shares can manage to catch a bid above the highs of the pattern at $59, then the red flag stops waving in this stock, and shares become likely to resume their uptrend. For that reason, it's critical to be reactionary with this trade (or any of the other ones on our list, for that matter). RBC doesn't become a high-probability sell until $56 gets busted.
Biotech firm Celgene (CELG - Get Report) is having a rough run. Since shares peaked last summer, this $90 billion biopharmaceutical company has given back about 20% of its market value, underperforming other healthcare sector stocks in a big way. Thing is, Celgene's selling isn't likely over yet -- and it doesn't take an expert technical trader to figure out why.
Celgene is currently stuck in a downtrending channel, a bearish price range formed by a pair of parallel trend lines that have corralled most of this stock's price action since last July. Every test of the top of the channel so far has provided shareholders with an optimal selling opportunity before the subsequent move lower. Shares are testing that trend line resistance level again this week after yesterday's big gains. From here, it makes sense to sell the next move lower.
Waiting for this week's 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 Celgene.
Aluminum giant Alcoa (AA - Get Report) has been in rebound mode lately, rallying as shares benefitted from climbing metals prices. But that rally is starting to show some cracks this spring thanks to a classic reversal setup that's been forming on Alcoa's price chart since the beginning of March. Here's how to trade it.
Alcoa is currently forming a head and shoulders top, a classic price pattern that signals exhaustion among buyers. The setup 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 Alcoa's neckline at the $9 price level. Put simply, if $9 gets violated, then Alcoa becomes a sell.
Price momentum is an extra red flag to watch in the Alcoa trade right now. Our momentum gauge, 14-day RSI, has been in a downtrend since the head and shoulders pattern started forming, making lower highs on each of the three peaks in the pattern. That's a bearish divergence from price that signals buyers have been quietly fading in shares of Alcoa. $9 is the line in the sand that makes Alcoa a toxic stock to own.