These 5 Stocks Are About to Turn Toxic
A big chunk of the market is sinking in 2016, and avoiding these underperformers could do more for your returns than owning the best performers.
Do you own any toxic stocks in your portfolio? The odds might be higher than you think.
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Fact is, the big index stats don't tell the whole story for 2016. While the S&P 500 is up by mid-single digits year to date, one in five S&P components is actually down 8% or more over that same period. That means there's a pretty substantial chunk of the broad market that's posting downright awful performance this year.
And simply not owning the very worst performers could do more for your returns than owning the best ones as we enter the final stretch of 2016.
To figure out which stocks to steer clear of, we're turning to the charts today for a technical look at five stocks that could be toxic for your portfolio 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, technical analysis 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.
This isn't the first time I've pointed out shipping company Frontline (FRO) as a toxic trade this year -- and for good reason. This billion-dollar seaborne transport stock has lost more than 40% of its market value since the calendar flipped to January.
The bad news for investors is that shares could still have further to fall from here.
Frontline is currently forming a descending triangle pattern, a bearish continuation setup that's formed by horizontal support down below shares at $7, coupled with a downtrending resistance level to the topside. Basically, as Frontline has bounced in between those two technically important price levels since this summer, shares have been getting squeezed closer and closer to a breakdown through support. When that happens, we've got our sell signal.
Relative strength, which measures Frontline's performance vs. the rest of the broad market, has been an extra piece of evidence against this stock in recent months. That's because Frontline's relative strength line has actually been in a downtrend stretching back to last fall, predisposing this stock to underperform going forward.
As long as that relative strength line keeps on pointing lower, this is a stock you don't want to own.
Kyocera
A similar pattern is in play in shares of Japanese tech giant Kyocera (KYO) right now, albeit with a bit of a twist. Kyocera has actually been a solid performer in recent months, up more than 27% since shares bottomed back in February.
But that rally is beginning to show some cracks, thanks to a descending triangle setup that's been forming long-term.
If Kyocera violates support at $46.50, it's time to sell.
What makes that $46.50 level in particular so significant? It all comes down to buyers and sellers. Price patterns, like this descending triangle setup in Kyocera, are a good quick way to identify what's going on in the price action, but they're not the actual reason it's tradable. Instead, the "why" comes down to basic supply and demand for shares of the stock itself.
The $46.50 support level in Kyocera is a place where there has 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 $46.50 so significant -- the move would mean that sellers are finally strong enough to absorb all of the excess demand at that price level.
Kyocera's price action isn't exactly textbook here. By that, I mean the descending triangle pattern is more commonly a continuation setup that comes after a downtrend than a bearish reversal that shows up after an uptrend.
But ultimately, that doesn't change the downside risks if $46.50 gets busted. The pattern may not be textbook, but it's tradable.
Callaway Golf
Callaway Golf (ELY) is another stock that's starting to show some serious cracks after a market-beating rally. This small-cap golf equipment maker is up more than 12% since the start of 2016, but that uptrend is over now that shares have violated a key support level at $11 this week. Here's what to expect next.
Callaway spent the last few months forming a double top pattern, a classic 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 trough that separates those two highs is the line in the sand that, if violated, triggers the sell.
For Callaway, that line is the aforementioned $11 support level that was broken this week.
From here, it's not clear where the selling stops in Callaway. This week's selling simultaneously violated $11 support for the double top pattern as well as the uptrend that's been connecting this stock's lows like clockwork stretching all the way back to February.
That dual sell signal means that investors should avoid Callaway until this stock can establish some semblance of support again.
Graco
Mid-cap industrial Graco (GGG) was a success story yesterday, rallying more than 5% on the heels of strong earnings results.
But, make no mistake, that upside pop doesn't mean that you want to own this stock. Quite the contrary.
Since peaking in April, Graco has been bouncing its way lower, selling off in a well-defined downtrending channel in the intervening months. That downtrend is formed by a pair of parallel trendlines that have corralled effectively all of this stock's price action during that time frame. So far, every test of the top of the channel has given sellers their best opportunity to get out before this stock's subsequent leg lower.
As Graco rebounds towards trendline resistance for a fourth time in October following earnings, it makes sense to sell the next bounce off the top of the channel.
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 Graco.
Alleghany
Last on our list of potentially toxic trades is $8 billion insurance company Alleghany (Y) . Alleghany may be up more than most stocks so far in 2016, but investors should avoid getting too comfortable here -- shares are teetering on the edge of a potentially large breakdown this fall.
Alleghany is currently forming a head and shoulders top, a reversal 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 breakdown through Alleghany's neckline, down just below the $515 level. Shares are within striking distance of violating that price level this week.
The side-indicator to watch in shares of Alleghany is price momentum, measured by 14-day Relative Strength Index at the top of this stock's chart. Our momentum gauge has made a series of lower highs since the pattern started forming, signaling that buyers are losing control of things as shares track sideways this fall.
Once Alleghany violates $515, it's time to sell.
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