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Stocks to 'succumb' to this classic theory: Technician

Stocks extended losses Monday as a massive selloff in China's Shanghai Composite rattled equities around the world, and if one classic technical indicator is correct, there could be more pain to come.

The Dow Jones transportation average has widely underperformed the broader market year-to-date, falling more than 12 percent while the Dow is down 2 percent and the S&P 500 is up less than 1 percent in the same period. This divergence, known as the Dow Theory, is an age-old technical indicator that suggests the broader market will follow suit.

"If you look at a long-term chart since the Ronald Reagan bull market began [in 1980] you have basically such epic outperformance [in the transports] even now with [them] down as much as they are," Carter Worth said Friday on CNBC's "Options Action." "This spread presumptively is not sustainable."

The Dow Jones transportation average is now down more than 13 percent from its high set in late November, with all but three stocks in the entire index are negative on the year. And Worth, who correctly called the top for the transports, is now setting his sights on individual names.

"The issue here is that some of the big names that really haven't fallen apart look as though they are going to succumb as well," said Worth.

Specifically, Worth looked at a troubling pattern that has formed on the UPS chart in the past year: a head and shoulders top. Technicians often look at these patterns as confirmation for a reversal in trend, and in this case, Worth sees the potential for a meaningful breakdown.

"If you look at the trendline that's been in effect over the last four or five years as a minor objective for this formation, it could get us down to around $89 in the stock," added Worth, head of technical analysis at Cornerstone Macro. That's a more than 5 percent decline from the current stock price of $95. "We would be short UPS here at a minimum of $89 or lower than that."

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