I mean, they're not next up in line at bankruptcy court. But that's frankly irrelevant; from a technical analysis standpoint, they're some of the worst positioned names out there 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 this fall. 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 planning their stock execution.
So, without further ado, let's take a look at five "toxic stocks" you should be unloading in 2013.
British American Tobacco
Up first is British American Tobacco, the $100 billion American depositary share (ADS) that owns cigarette brands such as Dunhill, Lucky Strike and Pall Mall. British American Tobacco hasn't been a strong performer so far in 2013 — in fact, shares have done a whole lot of nothing since the calendar flipped over to the new year. But that's not why this stock looks toxic. Instead, it comes down to the long-term setup in shares.
British American Tobacco has been forming a descending triangle pattern for most of the last six months as shares bounced between a trend line resistance level to the upside and horizontal support at $100 below shares. A breakdown below support is the sell signal for British American Tobacco.
With any technical pattern, it's critical to think in terms of buyers and sellers — not just shapes. After all, triangles, head and shoulders patterns and the like are a good way of describing what's happening on a chart, but they're not the reason why it's tradable. Instead, that all comes down to the supply and demand caused by those buyers and sellers.
The horizontal support level at $100 is a place where a glut of buyers has been willing to step in and put a floor in the stock. It's not incidental that support comes in at a round $100. That's a big psychological price for investors, and it stands to reason that bids would start falling off if shares fall below it. A breakdown would mean that increasingly eager sellers have absorbed all of the excess demand of shares sitting at that level — and without that floor in place, shares could fall much further than that.
It shouldn't be surprising that Gamco Investors is up more than 26 percent in the last six months. The investment manager lives and dies by the strength of the equity market, so with a major rally in stocks, more investors are willing to pony up for Gamco's expertise. But don't jump in just yet — shares look toppy right now.
That's because Gamco is currently forming a double top pattern, a setup that's formed by two swing highs that hit their heads at approximately the same price level. The sell signal comes on a breakdown below the near-term support level for shares, currently right at $53. If shares slip below that price, we've got a sell signal for shares. Momentum, measured by 14-day RSI, adds some extra evidence to this trade; the reading broke its uptrend at the start of the year.
I'll be the first to say that this is the least bad of the toxic stocks we're looking at today. After such a big move higher, consolidation isn't just healthy, it's necessary. So at this point, it's not clear whether buyers are taking a breather or if they're totally wiped out. The indicator is going to be whether shares fall through that $53 support level. Otherwise, GBL is buyable on a move through $58 resistance.
Just stay away from it while its stuck in between those two levels.
Turquoise Hill Resources
Things are a little bit more definitive in shares of Turquoise Hill Resources, a $7.7 billion mineral exploration firm. It doesn't take an expert technical analyst to see what's going on in this stock — shares have been in a well-defined downtrend for the better part of the last year.
It's significant that Turquoise Hill Resources' channel is well-defined; it means that we've got a high-probability range for shares to keep moving within. So now, with shares sitting smack dab in the middle of the channel, there's considerable room for urquoise Hill Resources to move lower before they can catch a bid again. Maybe worse, there's also a ton of room that this stock can move higher without actually breaking its downtrend. That fact could lure in more unsuspecting buyers only to have shares keep bouncing between trendline resistance and support.
The downtrend advises staying away from shares right now.
United Natural Foods
Mid-cap organic and specialty food distributor United Natural Foods has been all over the place in the last year. But zoom out a bit, and a clearer picture starts forming. You probably guessed: It's not a good one.
United Natural Foods is currently forming a head and shoulders top, a price pattern that indicates exhaustion among buyers. The head and shoulders is formed by two swing highs that top out around the same level (the shoulders), separated by a bigger peak called the head. The sell signal comes on the breakdown below the pattern's "neckline" level at $51. A shallow downtrend in RSI over the whole course of the pattern adds some extra bearish confirmation to a breakdown below United Natural Foods' $51 support level.
As a trader, it's critical to have a contingency plan. That means: When does this bearish setup break? If United Natural Foods can push through the top of its shoulder level at $56 (the red dashed line), we've got a good sign that more buyers have stepped in to buoy shares. Until then, $51 is our sell signal.
We're seeing the exact same setup right now in Indian communications stock Tata Communications. Like United Natural Foods, Tata is forming an ascending triangle, in this case with a neckline level at $8. The sell signal comes after a breakdown below that $8 level.
The head and shoulders pattern is well-known, but don't think that it's too high-profile to be worth trading. The research suggests otherwise: A recent academic study conducted by the Federal Reserve Board of New York found that the results of 10,000 computer-simulated head-and-shoulders trades resulted in "profits [that] would have been both statistically and economically significant."
That's reason to keep an eye on United Natural Foods and Tata Communications' neckline levels this week.