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Don't 'sift through the trash' for retail bargain buys, focus on these top performers, strategist says

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These retailers have been left out of the market rally

When it comes to retailers' stocks, investors should avoid the "dangerous, dangerous" temptation of shopping in the bargain basement, strategist Quint Tatro says.

Target, Home Depot, Lowe's and Dick's Sporting Goods shares soared on the back of solid earnings results this week, and the XRT, the ETF that tracks the retail sector, is now on pace for its best week of the year.

But it has been a tough environment for retailers as consumers move online and their tastes shift. Seventy-four percent of components in the XRT remain in correction territory, while 63% sit in a bear market.

Stock sell-offs can provide an opportunity for investors to pick up names that may have been unfairly punished, but Joule Financial's Tatro says that's not the case here. He believes these stocks should be avoided since they've moved lower thanks to poor fundamentals.

"I think it's very tempting for investors to sift through the trash trying to find something that's selling at a deep discount and they can pick it up for bargains, et cetera. That's a dangerous, dangerous play in this significantly changing environment," he said Thursday on CNBC's "Trading Nation."

While he's not shopping in the bargain bin, Tatro doesn't think the sector as a whole is uninvestable. Rather, he believes investors should focus on the retailers that have consistently performed and provided solid returns.

"I think you have to focus on the ones that are winning. Walmart, Target, Home Depot, these are companies that are executing in the online space and investors have been basically thinking that the good times are over and that these stocks are going to hit. When they're not, [investors] are rushing out to buy them again," he added.

Shares of Target gained more than 20% on Wednesday, soaring to a new all-time high and posting their best day in at least four decades, following earnings. Home Depot also hit an all-time high this week following quarterly results.

While Tatro likes these top-performing retailers, he says that investors should wait for the next pullback before jumping in.

"I wouldn't chase something like a Walmart here at 21 times forward earnings, but the next dip we get when everyone starts freaking out and selling stocks, those are the names you want to buy," he said. And, he reiterated, "absolutely avoid the ones in the trash."

Like Tatro, TradingAnalysis.com's Todd Gordon believes investors should avoid underperforming retail names, arguing that "the have-nots in retail are broken."

After examining the stock charts, he says Macy's and L Brands are names that should be avoided. Macy's has fallen 60% from its recent high, while L Brands has shed nearly 50%.

Gordon notes that when Macy's broke below the "key" $20 mark earlier this month, it was a "strong break from a technical point of view," which signaled that there might be more pain ahead for the retailer.

"I don't see a reason why we won't return back to single digits in Macy's." The stock was at $15.40 in Friday's premarket, down 1%.

After using the Fibonacci retracement patterns to identify key levels of support and resistance, Gordon says that L Brands' stock chart is also flashing a warning sign. The stock, which was trading down 3.5% at $19.33 in Friday's premarket,  "had the ability to hold the final Fibb. retracement," but it didn't, meaning that "there's no reason why we won't go back and retest the old lows."

"L Brands and Macy's — I would stay away from," he said.

Disclosure: Joule Financial owns shares of Walmart and Target.

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